The 2013-14 Budget: California's Fiscal Outlook

The 2013-14 Budget: California’s Fiscal Outlook MAC TAYLOR (cid:127) L E G IS L AT I V E A N AL Y ST (cid:127) NOVEMBER 2012 Table of Contents Chapter 1 The Budget Outlook ..................................................1 Chapter 2 Economy, Revenues, and Demographics .............. 11 Chapter 3 Expenditure Projections .........................................29 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook Legislative Analyst’s Office Legislative Analyst Mac Taylor State and Local Finance Education Jason Sisney Jennifer Kuhn Marianne O’Malley Edgar Cabral Chas Alamo Carolyn Chu Justin Garosi Rachel Ehlers Ryan Millera Paul Golaszewski Nick Schroeder Judy Heiman Brian Uhler Kenneth Kapphahn Mark Whitaker Paul Steenhausen Corrections, Transportation, and Environment Health and Human Services Anthony Simbol Mark C. Newton Farra Bracht Shawn Martin Brian Brown Ross Brown Aaron Edwards Lishaun Francis Anton Favorini-Csorba Eric Harper Jeremy Fraysse Rashi Kesarwani Anita Lee Lourdes Morales Lia Moore Janne Olson-Morgan Jessica Digiambattista Peters Felix Su Tiffany Roberts Ryan Woolsey Drew Soderborg Tor Tarantola Brian Weatherford Administration and Information Services Support Larry Castro Izet Arriaga Sarah Kleinberg Anthony Lucero Karry Dennis-Fowler Tina McGee Sarah Scanlon Michael Greer Jim Stahley Vu Chu Jim Will Douglas Dixon Sandi Harvey a Forecast coordinator. www.lao.ca.gov Legislative Analyst’s Office Executive Summary Budget Situation Has Improved Sharply. The state’s economic recovery, prior budget cuts, and the additional, temporary taxes provided by Proposition 30 have combined to bring California to a promising moment: the possible end of a decade of acute state budget challenges. Our economic and budgetary forecast indicates that California’s leaders face a dramatically smaller budget problem in 2013-14 compared to recent years. Furthermore, assuming steady economic growth and restraint in augmenting current program funding levels, there is a strong possibility of multibillion-dollar operating surpluses within a few years. The Budget Forecast Projected $1.9 Billion Budget Problem to Be Addressed by June 2013. The 2012-13 budget assumed a year-end reserve of $948 million. Our forecast now projects the General Fund ending 2012-13 with a $943 million deficit, due to the net impact of (1) $625 million of lower revenues in 2011-12 and 2012-13 combined, (2) $2.7 billion in higher expenditures (including $1.8 billion in lower-than-budgeted savings related to the dissolution of redevelopment agencies), and (3) an assumed $1.4 billion positive adjustment in the 2010-11 ending budgetary fund balance. We also expect that the state faces a $936 million operating deficit under current policies in 2013-14. These estimates mean that the new Legislature and the Governor will need to address a $1.9 billion budget problem in order to pass a balanced budget by June 2013 for the next fiscal year. Surpluses Projected Over the Next Few Years. Based on current law and our economic forecast, expenditures are projected to grow less rapidly than revenues. Beyond 2013-14, we therefore project growing operating surpluses through 2017-18—the end of our forecast period. Our projections show that there could be an over $1 billion operating surplus in 2014-15, growing thereafter to an over $9 billion surplus in 2017-18. This outlook differs dramatically from the severe operating deficits we have forecast in November Fiscal Outlook reports over the past decade. LAO Comments Despite Positive Outlook, Caution Is Appropriate. Our multiyear budget forecast depends on a number of key economic, policy, and budgetary assumptions. For example, we assume steady growth in the economy and stock prices. We also assume—as the state’s recent Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook economic forecasts have—that federal officials take actions to avoid the near-term economic problems associated with the so-called “fiscal cliff.” Consistent with state law, our forecast omits cost-of-living adjustments for most state departments, the courts, universities, and state employees. The forecast also assumes no annual transfers into a state reserve account provided by Proposition 58 (2004). Changes in these assumptions could dramatically lower—or even eliminate—our projected out-year operating surpluses. Considering Future Budget Surpluses. If, however, a steady economic recovery continues and the Legislature and the Governor keep a tight rein on state spending in the next couple of years, there is a strong likelihood that the state will have budgetary surpluses in subsequent years. The state has many choices for what to do with these surpluses. We advise the state’s leaders to begin building the reserve envisioned by Proposition 58 (2004) as soon as possible. Beyond building a reserve, the state must develop strategies to address outstanding retirement liabilities—particularly for the teachers’ retirement system—and other liabilities. The state will also be able to selectively restore recent program cuts—particularly in Proposition 98 programs (based on steady projected growth in the minimum guarantee). www.lao.ca.gov Legislative Analyst’s Office Chapter 1 The Budget Outlook This publication summarizes our office’s revenues and expenditures in that fiscal year— independent projections for California’s of $936 million. These estimates mean that the economy, tax revenues, and expenditures new Legislature and the Governor will need to from the state General Fund, as well as the address a $1.9 billion budget problem in order to Education Protection Account (EPA) created by pass a balanced budget in June 2013 for the next Proposition 30. Our forecast is based on current fiscal year. This is a dramatically smaller budget state law and policies, as discussed in the nearby problem than the state has faced in recent years. box (see page 2). Projected 2012-13 deficit of $943 Million Higher Spending and Lower Revenues Contribute to Deficit. The $1.9 billion The BudgeT FOreCAsT deterioration in the 2012-13 budget situation is due to the impact of (1) $625 million of lower Projected $1.9 Billion Budget Problem revenues in 2011-12 and 2012-13 combined, Must Be Addressed by June 2013. The 2012-13 (2) $2.7 billion in higher expenditures, and Budget Act assumed a year-end reserve of (3) an assumed $1.4 billion positive adjustment $948 million. As shown in Figure 1, assuming in the 2010-11 ending budgetary fund balance. that no corrective budgetary actions are taken, we project that the state will close 2012-13 with a Figure 1 $943 million deficit. As LAO Projections of General Fund Condition discussed later, lower- If No Corrective Actions Are Taken than-expected savings related to the dissolution (In Millions, Includes Education Protection Account) of redevelopment 2011-12 2012-13 2013-14 agencies (RDAs) Prior-year fund balances -$1,285 -$1,885 -$224 and other budgetary Revenues and transfers 86,482 95,610 96,743 erosions contribute to Expenditures 87,082 93,950 97,679 this shortfall. We also Ending fund balance -$1,885 -$224 -$1,160 expect that the state faces Encumbrances 719 719 719 an operating deficit in Reservea -$2,604 -$943 -$1,879 2013-14—the difference a Special Fund for Economic Uncertainties. Assumes no transfers to the state’s Budget Stabilization Account. between current-law Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook (The box on page 3 discusses the subject of and EPA combined, we currently project that revenue accruals—reportedly responsible for the 2011-12 revenues will be $348 million less than fund balance adjustment—and other accounting assumed in the 2012-13 budget package and issues related to the state budget.) that 2012-13 revenues will be $277 million less than assumed, for a total of $625 million less in Revenue Estimates Down Somewhat From revenues for these two fiscal years combined. The Budget Act Assumptions. The 2012-13 budget largest differences in this regard relate to the PIT package assumed that Proposition 30 would and CT, as follows: pass—thereby temporarily levying additional personal income taxes (PITs) and sales and use • Facebook Offsets Other Projected PIT taxes and depositing them to a new state fund, Gains. Our updated estimate of revenues the EPA. Our forecast includes updated estimates related to the initial public offering (IPO) concerning Proposition 30 tax receipts and the of stock by Facebook, Inc., is lower than rest of the state’s revenues. It also adds increased that assumed in the budget package—by corporation tax (CT) revenues based on voters’ $626 million spread across 2011-12 and approval of Proposition 39. For the General Fund 2012-13. On the other hand, our forecast Basis for Our Projections This forecast is not intended to predict budgetary decisions by the Legislature and the Governor in the coming years. Instead, it is our best estimate of revenues and expenditures if current law and current policies are left in place through 2017-18. Specifically, our estimates assume current law and policies, including those in the State Constitution (such as the Proposition 98 minimum guarantee for school funding), statutory requirements, and current tax policy. Our forecast projects future changes in caseload and accounts for relevant changes in federal law and various other factors. Effects of November 2012 Voter Initiatives Included. Our forecast reflects the approval by voters of Propositions 30, 35, 36, 39, and 40 at the November 6, 2012 statewide election. COLAs and Inflation Adjustments Generally Omitted. Consistent with the state laws adopted in 2009 that eliminated automatic cost-of-living adjustments (COLAs) and price increases for most state programs, our forecast generally omits such inflation-related cost increases. This means, for example, that budgets for the universities and courts remain fairly flat throughout the forecast period and that state employee salaries do not grow except for already- negotiated pay increases. We include inflation-related cost increases when they are required under federal or state law, as is common in health and social services programs. Uncertainty Surrounding Federal Fiscal Policy. There is great uncertainty surrounding the federal “fiscal cliff,” the combination of tax increases and spending cuts set to take place under current federal law in 2013. These policies, if left unchanged, would have a significant effect on the economy and could result in economic conditions differing materially from our forecast. As discussed in Chapter 2, our forecast makes a number of assumptions regarding the federal fiscal cliff and its effect on the California economy. In general, we assume that federal policy makers take actions to avoid virtually all major near-term effects of the fiscal cliff. 2 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook recent Accounting Issues That Affect the state Budget Process This box discusses two accounting issues that have risen in prominence recently: the state’s revenue accrual policies and accounting practices for the state’s over 500 special funds. The State’s Revenue Accrual Policies. The state commonly adjusts the prior year’s ending fund balance as part of the budget process—to reflect updated information concerning spending or revenue accrual estimates. The $1.4 billion positive fund balance adjustment (preliminary and subject to change) recently reported to us by the Department of Finance is related to updated revenue accruals. In our budgetary process, accruals are used to allocate tax revenues—generally paid on a calendar year basis—to a particular fiscal year. The general idea is to assign the revenue to the fiscal year in which the economic activity producing the revenue occurred. In recent years, the state has altered its accrual policies. Some of the changes have a theoretical basis in accounting principles, but their effect has been to move more revenue collected in one fiscal year to a prior fiscal year (thereby helping to balance the state budget). The changes also affect calculation of the Proposition 98 minimum guarantee. (We discussed revenue accruals in our January 2011 publication, The 2011-12 Budget: The Administration’s Revenue Accrual Approach.) Section 35.50 of the 2012-13 Budget Act institutes a new accrual method for the tax revenues generated by Propositions 30 and 39. A portion of final income tax payments paid in, say, April of one year will be accrued all the way back to the prior fiscal year (which ended ten months in the past). One effect of the change is that we will no longer have a good idea of a fiscal year’s revenues until one or two years after that fiscal year’s conclusion. Because the volatile capital gains-related revenues from Proposition 30 are the subject of the accrual changes, the late adjustments to revenues could total billions of dollars—much more than in the past. As a result, the chances of large forecast errors by us and the administration will increase. We are now convinced that the problems that this new accrual method will introduce to the budgetary process outweigh its benefits. We recommend that the Legislature direct the administration to develop a simpler, logical budgetary revenue accrual system by 2015. Alternatively, to help ensure the accuracy of our forecasts and improve transparency, we recommend that the Legislature require the administration to document accruals regularly online. Special Fund Accounting Practices. In response to this year’s Department of Parks and Recreation accounting issues, the Legislature passed Chapter 343, Statutes of 2012 (AB 1487, Committee on Budget), to ensure that special fund information was presented in the Governor’s budget on the same basis as that used in the Controller’s budgetary accounting reports. We expect that the 2013-14 Governor’s Budget will include updated information on special fund balances in response to these requirements. Legislative committees will want to scrutinize the condition of special funds with significant discrepancies compared to prior administration reports. Decisions about when special fund loans are repaid by the General Fund could materially affect the condition of special funds in the coming years. When considering whether or not to extend repayment dates of existing loans or authorize new loans, the Legislature will want to consider: (1) whether special fund programs are meeting legislative expectations; (2) whether a General Fund loan repayment would facilitate one-time or permanent fee decreases, either immediately or over time; (3) whether existing priorities for special fund programs should be changed; and (4) the relative prioritization of General Fund and special fund activities. 3 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook of non-IPO PIT revenues is higher across • $400 Million of Cap-and-Trade General these two fiscal years by $473 million. In Fund Savings Unlikely to Materialize. total, PIT revenues in 2011-12 and 2012-13 The 2012-13 budget included savings are forecast to be $153 million below associated with the state’s cap-and-trade budget act assumptions. (Due to the state’s program. Specifically, the budget package new revenue accrual policies related to assumed that $500 million in revenues Proposition 30, we note that the books will generated by the program’s auctions would not be closed on 2011-12 revenues until at offset costs traditionally supported by the least a year from now.) General Fund. Consistent with our prior estimates, our forecast projects that only • Proposition 39 Revenues Offset Lower $100 million of such costs could be offset CT Estimates. Estimated CT revenues by the revenues, resulting in a $400 million in 2011-12 were $605 million below the budgetary erosion. assumption in the budget act. In keeping with recent, very weak collection trends, we • Healthy Families Program (HFP) Costs. also forecast that CT revenues under prior The 2012-13 budget package included a tax law will be about $403 million lower $183 million reduction to HFP. As explained than the budget act assumption in 2012-13. in Chapter 3, our forecast assumes the These declines, however, will be partially reduction will not be put in place because offset by the passage of Proposition 39, it would violate a maintenance-of-effort which changes the method by which requirement under the Patient Protection some multistate businesses calculate and Affordable Care Act, the federal health their taxable income. We estimate that care reform law. Proposition 39 will increase CT revenues by about $450 million in 2012-13. In total, • Wildfire-Related Costs. The 2012-13 therefore, our forecast of CT revenues Budget Act included $92.8 million in in 2011-12 and 2012-13 combined is General Fund support for emergency fire $558 million below the amount assumed suppression activities. Due to heavy fire in the 2012-13 budget act. activity during the early part of 2012-13, CalFire has requested an additional Significant 2012-13 Budget Actions at Risk. $118 million in funding. While the federal Our forecast projects $2.7 billion in higher government or local fire agencies will expenditures will contribute to a year-end deficit eventually reimburse the state for some in 2012-13. These include budgetary erosions of this funding, our forecast treats the associated with several actions adopted in the entire amount as an increased cost because 2012-13 budget package, including the following: the amount of future reimbursement is unknown. • RDA Savings Will Be Much Less. As described further in Chapter 3, the budget relatively small Budget Problem package assumed about $3.2 billion in Forecasted for 2013-14 General Fund savings related to the disso- Many Factors Contribute to the 2013-14 lution of RDAs. We estimate, however, that Operating Deficit. The combination of recent the savings will total about $1.8 billion less spending reductions and temporary tax than assumed in the budget. increases—plus improvement in the economy— has virtually eliminated the state’s “structural 4 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook deficit.” Accordingly, we estimate that the state is funds, consistent with previous loan repayment poised to record a substantial operating surplus schedules provided by the administration. (We in 2012-13—which was necessary to eliminate note that the administration has substantial most of the carry-in deficit related to prior years’ flexibility, in many cases, to delay such budgetary problems. In 2013-14, however, our planned repayments.) Revenue growth of forecast projects a $936 million operating deficit, about $1.1 billion over 2012-13 partially offsets assuming current law policies. $3.7 billion in increased expenditures in our forecast. Many factors contribute to the small operating deficit we forecast in 2013-14. General Operating surpluses Projected Fund Proposition 98 payments, for example, Over the Next Few Years grow by $1.8 billion. Also, actions to achieve State “In the Black” After Years of Major savings in employee compensation—including Operating Deficits. Under current law, General furloughs and the Personal Leave Program— Fund and EPA expenditures are projected to expire in June 2013, consistent with current grow less rapidly than revenues, given our labor agreements. Combined with scheduled current economic forecast. Beyond 2013-14, we Graphic Sign Off pay increases and higher premium costs for therefore project growing operating surpluses state employees’ health care benefits, we project throughout the forecast period. As indicated Secretary that employee compensation costs will increase in Figure 2, our forecast shows that there could Analyst by more than $750 million in 2013-14. We also be an over $1 billion operating surplus in Director project that General Fund debt-service costs 2014-15, growing thereafter to an over $9 billion related to infrastructure bonds will grow by surplus in 2017-18. A contributing factor to th D e e puty $759 million in 2013-14. (These debt-service surpluses beginning in 2016-17 is the end of costs go up in 2013-14 primarily because the the “triple flip,” the financing mechanism used state structured its infrastructure bonds so that payments were lower in 2012-13. The state did this to Figure 2 accommodate the required, Forecasted Operating Surpluses Beginning in 2014-15 one-time repayment this year of a $2 billion loan from General Fund and Education Protection Account Combined (In Billions) local governments, which $12 the Legislature authorized in 2009 with its suspension of 10 Operating Surpluses Proposition 1A [2004].) Operating Deficit for 2013-14 8 Carry-In Deficit From 2012-13 The expiration of 6 various one-time actions in the 2012-13 budget also 4 contribute to the operating 2 deficit, including about $419 million in higher expenditures for the judicial branch. We also assume -2 that the state repays about -4 $1.1 billion of loans to special 2013-14 2014-15 2015-16 2016-17 2017-18 5 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #120534 California’s Fiscal Outlook for the 2004 economic recovery bonds (ERBs). Federal Fiscal Policy Poses Risk to Revenue (Specifically, the General Fund benefits—to the Forecast. As discussed in Chapter 2, the tune of about $1.6 billion per year—once the federal fiscal cliff poses a significant risk to our ERBs are retired, which will result in higher economic and revenue forecast. Specifically, if the local funding for school districts and a related Congress and the President are unable to resolve decrease in state funding requirements for the fiscal cliff, the economy could enter recession schools.) This outlook of significant operating beginning in 2013. We examined one possible surpluses differs dramatically from the severe recession scenario in which state revenues were operating deficits we have forecast in November about $11 billion lower than in our forecast for Fiscal Outlook documents over the past decade. 2012-13 and 2013-14 combined. This scenario obviously would also delay any potential future operating surpluses. LAO COMMeNTs Forecast Assumes No Transfers to the BSA. Proposition 58 (2004) generally requires despite Positive Outlook, 3 percent of estimated General Fund revenues Caution Is Appropriate to be transferred each year to the Budget Several Assumptions Key to Achieving Stabilization Account (BSA), the state’s rainy Future Surpluses. Our multiyear budget forecast day fund. The state has made such transfers in depends on a number of economic, policy, and the past, but the Governor has suspended the budgetary assumptions that, if changed, could requirement annually since 2008-09 due to the result in dramatically different outcomes. As state’s persistent budget problems. Our forecast discussed below, a variety of alternate scenarios assumes that no transfer will be made during the would result in much smaller future operating forecast period. As shown in Figure 3, however, a surpluses or possibly operating deficits. transfer of 3 percent of General Fund revenues to the BSA beginning in 2015-16 would reduce the Revenue Forecast Assumes Steady Growth operating surpluses by over $3 billion per year. in the Economy and Stock Prices. Our forecast assumes steady economic growth, fueled in Forecast Assumes No COLAs or Inflation particular by recent encouraging data about Adjustments. Consistent with state law and the state’s housing market and income trends. recent state policy, our forecast includes no In one alternative scenario we considered— cost-of-living adjustments (COLAs) or price assuming the economy underperforms and increases over the forecast period, except when state revenues grow one-third slower than required under federal or state law. As shown forecasted—80 percent of the surplus shown in in Figure 3, if we included COLAs and price Figure 2 for 2017-18 would be eliminated, and increases for state operations (including the prior fiscal years would be much more likely universities and the judicial branch) each year to have an operating deficit. Our forecast also of the forecast, operating surpluses would be assumes steady growth in the stock market, around $2.1 billion lower by 2017-18. which results in taxable capital gains. As we have pointed out many times over the years, Forecast Does Not Account for Repayment these gains are notoriously volatile and hard to of Many Obligations. Our forecast assumes predict. They are a key reason why tax revenue that the state initiates no additional loans from forecasts can easily be a few billion dollars special funds to the General Fund (except those lower (or higher) than projected by us or the already envisioned in the 2012-13 budget plan), administration in any given fiscal year. and that these loans are repaid when scheduled 6 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook or otherwise required—generally consistent taxpayers through 2016 and PIT rates on upper- with recent repayment schedules provided by income taxpayers through 2018. In 2017-18, the the administration (and, in some cases, with last fiscal year of our forecast, we estimate that repayment deadlines included in prior budget the higher PIT rates will raise about $5.6 billion acts). As a result, in our forecast, the $4.3 billion in additional revenues. When those taxes expire loan balance currently owed to special funds by beginning in 2018-19 (outside the time period the General Fund is reduced to $3.1 billion by considered in our forecast), ongoing surpluses the end of 2013-14 and $1.2 billion by the end could be several billion dollars lower. of our forecast period in 2017-18. The Governor, however, has stated his preference to pay down Considering Future Budget surpluses this and other elements of the so-called “wall of As noted above, there are many ways that debt” within a few years. If the Legislature and the future operating surpluses we now project the Governor seek to repay these obligations, could disappear or be reduced substantially. surpluses could be lower in some years. If, however, the state’s leaders choose to keep a tight rein on the budget over the next year and Revenue Volatility and Maintenance the economy avoids another recession over the Factor. As discussed in our May 2012 report, next several years, they could experience the Proposition 98 Maintenance Factor: An Analysis operating surpluses shown in Figure 2. During of the Governor’s Treatment, the maintenance the 2013-2014 legislative session, lawmakers factor approach used in building the 2012-13 may want to begin considering how to use budget can ratchet up Proposition 98 spending such potential surpluses. There are a variety of in certain situations. This ratcheting effect is priorities for surplus funds, as described below. most likely to occur in years with significant year-to-year increases in General Fund revenues. Building a Reserve? As noted above, Because Proposition 98 appropriations in one Proposition 58 generally requires that year typically are used to calculate the minimum 3 percent of estimated General Fund revenues guarantee in the next year, a significant increase be deposited in the BSA, the state’s rainy in the Proposition 98 minimum guarantee Figure 3 for one year also would likely increase the state’s Alternate Forecasts of General Fund Operating Surpluses obligations in future (In Millions, Includes Education Protection Account) years. Although such 2015-16 2016-17 2017-18 ratcheting does not occur in our current forecast, Budget Forecast Revenues and transfers $111,017 $116,461 $121,627 this situation is possible Expenditures 106,728 108,962 112,047 over the forecast period, Operating Surplus $4,289 $7,499 $9,580 particularly given the Alternate Scenarios inherent volatility of PIT Transfer 3 percent of General Fund revenues to BSAa -$3,331 -$3,494 -$3,649 revenues. Grow state operations and judiciary budget by inflation -1,189 -1,624 -2,140 Subtotals -$4,520 -$5,118 -$5,789 Proposition 30 Tax Alternate Scenario Operating Deficit/Surplus -$231 $2,381 $3,791 Increases Temporary. a Calculates transfer amount as a percentage of combined General Fund and Education Protection Account revenues. Up to Proposition 30 increases 50 percent of the funds transferred to the BSA could be used to repay ERBs. Our forecast assumes ERB debt is retired in 2016 without any transfers from the BSA. the sales tax rate for all BSA = Budget Stabilization Account; ERB = Economic Recovery Bonds. 7 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook day fund. Beginning in 2015-16, we project for benefits already earned by current and past potential surpluses that would accommodate public employees. While this year’s pension such a transfer. Within the next few years, legislation reduces significantly the net employer we advise the Legislature and the Governor cost of benefits that will be earned by future to begin building the reserve envisioned by public employees, these unfunded liabilities Proposition 58, which could buy time to deal must still be addressed. As such, one possible with the budgetary problem accompanying the use for potential surpluses is paying down next economic downturn. While our forecast these significant liabilities, which total over does not assume such a downturn, one could $150 billion. easily materialize by 2018. For this reason, we favor BSA deposits as one priority for the use of A key priority of the state in this regard available resources over the next few years. probably should be a funding plan to address CalSTRS’ unfunded liabilities. Additional Paying Down Budgetary Liabilities? As funding from the state, districts, and/or teachers discussed above, our forecast assumes that of over $3 billion per year (and growing over special fund loans to the General Fund are paid time) likely will be required to keep CalSTRS back consistent with recent repayment schedules solvent and retire its unfunded liabilities over provided by the administration and that the next several decades. Under a resolution $1.2 billion of such loans remain outstanding by approved by both houses of the Legislature this the end of 2017-18. The state could choose to pay year, CalSTRS will submit several proposals in down these loans faster. Paying down the loans February 2013 for how to better fund the system faster would relieve the General Fund of some in the future. Assisting UC in rebuilding the additional interest costs, allow special funds to funding status of its pension system is another either expand programs or reduce fees, and serve possible priority for surplus funds. Addressing as a possible additional budget cushion for the these unfunded liabilities sooner likely would General Fund during future recessions (since save state and local funds, compared to the costs special fund balances available to be borrowed at of funding them down the road. This is because that time could be larger). Other elements of the contributing funds to the pension systems sooner wall of debt (such as addressing the backlog of means that the systems can invest the funds and payments related to local government mandates) generate investment returns earlier than would also could be funded from any surpluses that otherwise be the case. materialize. Still, other elements of the wall of debt could be retired with funds made Selectively Restoring Cuts? The state has available as part of the Proposition 98 minimum reduced spending in recent years in most areas, guarantee each year. including health and social services programs, schools, universities and community colleges, the Addressing Retirement Liabilities? Unfunded courts, and state administration. The state has liabilities of the state’s key pension systems—the also generally not provided COLAs or inflation California Public Employees’ Retirement System, adjustments for most of these programs. A key the California State Teachers’ Retirement System decision to consider for possible budget surpluses (CalSTRS), and the University of California will be to what extent to use them to restore (UC) Retirement Plan—and the retiree health some of these cuts. (In Chapter 3 of this report, programs serving state government (including for example, we discuss potential priorities for the California State University system) and UC the state in the use of increased Proposition 98 represent funds not currently set aside to pay school funding over the next few years.) 8 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook Investing in Infrastructure? Another option approach to planning and financing it is needed, for the use of potential surpluses would be as we discussed in the August 2011 report. investment in the state’s infrastructure. Our forecast, for example, assumes no additional Conclusion bond authorizations for infrastructure even The state’s economic recovery, prior budget though several programs, such as K-12 and cuts, and the temporary taxes provided higher education, have exhausted most of their by Proposition 30 have combined to bring existing bond authority. Our forecast also does California to a promising moment: the possible not include bond payment costs related to the end of a decade of acute state budget challenges. $11 billion water bond now scheduled for the If a steady economic recovery continues and November 2014 statewide ballot. In our August the Legislature and the Governor keep a tight 2011 report, A Ten-Year Perspective: California rein on state spending in the next couple of Infrastructure Spending, we noted various major years, there is a strong likelihood that the state infrastructure funding needs for the state, will have operating surpluses in subsequent including those related to aging infrastructure years. The state has many choices for what to and a growing backlog of deferred maintenance. do with these surpluses. We advise the state’s leaders to begin to build the reserve envisioned To effectively assess the enormous variety and by Proposition 58 as soon as possible. Beyond complexity of the state’s infrastructure needs, the building a reserve, the state must develop state needs a well-defined process for planning strategies to address several substantial liabilities and financing projects. Unfortunately, the state that will have to be paid—most notably, does not have such a process. Particularly in the unfunded retirement liabilities and outstanding event that the state pursues a new infrastructure loans from the state’s special funds to the investment program in the coming years, a new General Fund. 9 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook 10 www.lao.ca.gov Legislative Analyst’s Office Chapter 2 Economy, Revenues, and Demographics eCONOMIC OuTLOOk California economic forecasts, including the Department of Finance’s (DOF) May Revision Figure 1 shows a summary of our forecast for forecast (which was used as the basis for revenue both the U.S. and California economies through assumptions in the 2012-13 Budget Act). 2018. Figure 2 (see next page) compares the near-term economic forecast with other recent U.S. Economic Forecast Down, State Forecast Up From Budget Act Forecast. In Figure 1 LAO Economic Forecast Summary United States 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Unemployment rate 9.3% 9.6% 8.9% 8.2% 8.0% 7.6% 6.9% 6.4% 6.2% 6.0% Percent change in: Real gross domestic product -3.1% 2.4% 1.8% 2.1% 1.8% 3.0% 3.4% 2.9% 2.7% 2.5% Personal income -4.8 3.8 5.1 3.5 3.9 4.9 4.9 4.9 4.3 4.4 Wage and salary employment -4.4 -0.7 1.1 1.4 1.3 1.8 2.0 1.8 1.3 0.9 Consumer price index -0.4 1.6 3.2 2.0 1.3 1.7 1.7 1.9 1.9 2.0 Housing starts (thousands) 554 587 609 751 949 1,276 1,587 1,690 1,713 1,709 Percent change from prior year -38.8% 5.9% 3.7% 23.3% 26.4% 34.5% 24.4% 6.5% 1.4% -0.2% S&P 500 average monthly level 947 1,139 1,269 1,384 1,476 1,541 1,615 1,684 1,751 1,817 Percent change from prior year -22.5% 20.3% 11.4% 9.0% 6.7% 4.4% 4.8% 4.3% 3.9% 3.8% Federal funds rate 0.2 0.2 0.1 0.1 0.1 0.1 0.6 2.6 4.0 4.0 California 2009 2010 2011 2012a 2013a 2014 2015 2016 2017 2018 Unemployment rate 11.4% 12.3% 11.8% 10.6% 9.6% 8.7% 7.8% 7.1% 6.7% 6.7% Percent change in: Personal income -5.8% 3.1% 5.2% 4.1% 4.7% 5.5% 5.8% 5.4% 4.9% 4.7% Wage and salary employment -6.0 -1.1 0.9 1.7 2.3 2.5 2.6 2.1 1.7 1.1 Consumer Price Index -0.3 1.3 2.6 2.2 1.3 1.7 1.7 1.9 1.9 2.0 Housing permits (thousands) 36 45 47 63 83 113 139 155 168 164 Percent change from prior year -43.9% 23.0% 5.9% 32.6% 32.6% 35.8% 22.4% 11.6% 8.4% -1.9% Single-unit permits (thousands) 25 26 22 27 37 53 70 80 87 82 Multi-unit permits (thousands) 11 19 26 36 46 61 68 75 81 83 a Generally excludes extraordinary one-time personal income effects of Facebook, Inc. initial public offering. These effects will be displayed in future official economic data for 2012 and 2013. Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook general, our updated U.S. economic forecast economic data in the coming months. One is somewhat weaker than the forecast upon possibility is that the storm’s effects will reduce which the 2012-13 Budget Act was based. This is U.S. gross domestic product [GDP] growth below based on recent trends in the nation’s economy, our forecast by a few tenths of a percentage point including apparent hesitation by businesses in the fourth quarter of 2012, but add back about to invest and hire due in part to uncertainty that amount to GDP in the following quarter due concerning future federal tax and fiscal to reconstruction efforts.) policies. At the same time, we are somewhat more optimistic about the California economy u.s. economy than we were in prior months due to rising Slow Recovery From a Severe Economic strength in the state’s depressed housing market, Contraction. The 2007-2009 recession was vehicle sales, and various employment trends. the most severe economic contraction since Nevertheless, as noted below, this remains a slow the Great Depression. Moreover, as shown in economic recovery by historical standards. Figure 3, the nation’s recovery from the recession has been slow by historical standards. Following (We note that our economic forecast was the 1981-1982 recession, U.S. real GDP expanded developed prior to both the election and the date at 3.5 percent or greater in each of the next on which Hurricane Sandy struck New Jersey four years, and the nation’s employment grew and New York. Sandy is likely to affect national at 2.5 percent or greater in five of the six years Figure 2 Comparing This Economic Forecast With Other Recent Forecastsa 2012 2013 DOF LAO UCLA LAO DOF LAO UCLA LAO May May September November May May September November 2012 2012 2012 2012 2012 2012 2012 2012 United States Percent change in: Real Gross Domestic 2.2% 2.2% 2.1% 2.1% 2.4% 2.4% 1.7% 1.8% Product Employment 1.6 1.6 1.4 1.4 1.7 1.7 1.4 1.3 Consumer Price Index 2.1 2.2 2.0 2.0 2.0 1.7 1.7 1.3 S&P 500 Stock Indexb 8.1 9.2 NA 9.0 3.5 4.0 NA 6.7 Unemployment Rate 8.2 8.2 8.2 8.2 7.9 7.9 8.0 8.0 Federal Funds Rate 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.1 California Percent change in: Personal Income 4.9c 3.9 3.0 4.1 3.4c 4.7 4.1 4.7 Employment 1.4 1.7 1.7 1.7 1.9 2.1 1.5 2.3 Unemployment Rate 10.9 10.7 10.7 10.6 10.4 9.9 9.8 9.6 Housing Permits (thousands) 53 59 50 63 81 69 69 83 a Recent DOF and LAO economic forecasts generally assume that Congress and the President agree to extend the “Bush tax cuts” and recent payroll tax cuts beyond their scheduled expiration dates at the end of 2012 and also lower spending more gradually than the current-law federal sequestration plan indicates. b Based generally on assumed average daily closing levels of the index and the resulting year-over-year changes in such levels. c The DOF May 2012 economic forecast includes various effects of the initial public offering (IPO) of stock by Facebook. The LAO economic forecasts largely or entirely exclude the effects of the IPO. If the IPO had been excluded from the Governor’s May 2012 economic forecast, growth in California personal income would have been 4.0 percent in 2012 and 4.2 percent in 2013. Both LAO and administration revenue forecasts since February 2012 have included effects of the IPO. DOF = California Department of Finance; UCLA = UCLA Anderson Forecast for the Nation and California; NA = not available. 12 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook during the 1984-1989 period. After the 1990-1991 U.S. economic recovery is so slow, relative to recession, GDP grew by 3 percent to 5 percent historical standards. in all but two years between 1992 and 2000, while employment grew by 2 percent to 3 percent Federal Policy Important in the Forecast. annually through almost all of that period. The U.S. government borrowed significant amounts—including from international As shown in Figure 3, the current recovery— lenders—before, during, and after the recession from the far more severe economic contraction to address the collapse of the financial sector, of 2007-2009—is slower than the two recoveries support some other economic sectors (such as described above in several respects. To date, GDP the automotive industry and state and local growth since the recession has been in the range governments), and provide economic stimulus. of 2 percent per year, and we forecast that it will The Federal Reserve also has taken significant remain between 2 percent and 3 percent per monetary policy actions intended to support the year in all but one year between now and 2018. economy. As discussed later in this chapter, the United States employment is forecast to grow at U.S. government now faces major decisions about 2 percent or less each year through 2018. the future course of its fiscal and tax policies.G raphic Sign Off These decisions have the potential to alter our Reasons for the Slow Recovery. Unlike other economic forecast significantly over the next Secretary recent recessions, the 2007-2009 downturn was few years. In the worst case, federal decisions Analyst caused by an implosion of the nation’s financial concerning the so-called “fiscal cliff” could Director sector and housing markets. This resulted in plunge the U.S. economy into recession in 2013 Deputy significant harm to banks’ balance sheets, as well and result in much weaker economic conditions as the balance sheets of households—particularly in the near term than reflected in our forecast. those that saw their net worth decline with the collapse of home values. Since the recession, financial Figure 3 institutions, households, U.S. Recovery From Recent Recession and many businesses have Slow by Historical Standards been “deleveraging”— Percent Change From Prior Year rebuilding their net worth and balance sheets step by 8% U.S. Real Gross Domestic Product painful step. Deleveraging Forecast U.S. Employment requires saving, reducing 6 consumption, and, in some cases, shedding liabilities 4 through bankruptcies and renegotiation with 2 creditors. Households and businesses are less capable of prodding the economy forward through spending, -2 and financial institutions are less able to lend to facilitate -4 such spending. These are -6 some of the reasons why the 1980 1985 1990 1995 2000 2005 2010 2015 13 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #120534 California’s Fiscal Outlook California economy the pre-recession peak. After the 1990-1991 California Also Recovering Slowly From the recession and the resulting cutbacks in the Recession. A similarly tepid recovery—compared defense industry, it took over five years. After to historical standards—is occurring in the the 2001 recession and the bust of the “dot-com” California economy. The 2007-2009 recession bubble, it took four years. As shown in the figure, was much more severe than recent downturns. the total decline in jobs during and after the Similar to the nation, personal income growth 2007-2009 recession—about 1.4 million jobs in California following the 2007-2009 recession (9 percent of seasonally-adjusted employment)— has been much lower than after recent recessions. was far greater than in the prior recessions The rate of employment growth also has been shown. Moreover, the projected recovery period slower. These trends are projected to continue in is much longer than for the prior recessions our forecast, although the recovery we are now shown. Our forecast assumes that seasonally projecting in the housing market is assumed to adjusted employment in California reaches its increase employment growth over the next four pre-recession peak in early 2015, or 7.5 years years, compared to what it would be otherwise. after its pre-recession peak in July 2007. (In 2015, California’s unemployment rate is projected to be Graphic Sign Off Figure 4 shows another way to look at around 8 percent—around 2 percentage points the slowness of the current recovery in higher than Sit ewcarse itna r2y007—due in part to the California. Covering the periods after the last state’s growing population over the period.) Analyst four recessions, this figure shows how long Director it took California’s economy to return to the Improvements in Job Market. Despite the pre-recession peak level of jobs. After the slowness of tDhiesp ruectyovery, improvements in 1981-1982 recession, it took over two years for the state’s job market are evident. California the number of jobs in California to return to now has regained 500,000 of the 1.4 million jobs it lost between July 2007 and February 2010, Figure 4 including a net gain of Jobs in California Recovering Much 262,000 jobs (1.9 percent) More Slowly Than in Prior Recoveries since September 2011. Job Loss and Years to Return to Pre-Recession Employment Peak (This was faster than the national rate of employment 1 2 3 4 5 6 7 0% growth—1.4 percent—over the same time period.) Due in part to some improvement -2 in the housing sector, even California’s weakened -4 construction industries now are adding jobs—up about Forecast 26,000 (4.7 percent) in the -6 past year. Every category of 1981-1983 1990-1995 construction jobs—except 2001-2005 highway, street, and -8 2007-2015 bridge construction—has contributed to these gains. -10 14 www.lao.ca.gov Legislative Analyst’s Office ARTWORK #120534 California’s Fiscal Outlook Manufacturing and Government Are Weak multi-family unit building permits declined from Job Sectors. While manufacturing employment their combined peak of around 210,000 units has grown 1.5 percent for the U.S. as a whole over annually in 2004 to just 36,000 units in 2009. the past year, recent monthly jobs reports show Not surprisingly, construction-related jobs were that manufacturing jobs continue to decline in one of the state’s most significantly weakened California—now down 11,000 jobs (0.9 percent) employment sectors. from one year ago. Moreover, while government employment has stabilized nationally, the Recent Housing Market Activity Stronger combined number of federal, state, and local Than Previously Expected. A number of government jobs in California has declined— factors suggest that the demand for housing in down 1.7 percent from one year ago. The bulk of California has picked up significantly from last the decrease is attributable to a drop of 35,000 year. Home prices in Los Angeles, San Diego, jobs in local government educational services and San Francisco increased for the eighth (a decline of 4 percent of jobs in this category). consecutive month in August. Prices also have Manufacturing and government, therefore, are increased lately in the area’s most affected by notable weak spots in an otherwise improving the housing crisis: the Central Valley and theG raphic Sign Off job situation in the state. Inland Empire. In addition, monthly rents have increased throughout the coastal regions of Secretary housing recovery the state, with some areas posting double-digAit nalyst Is strengthening somewhat annual increases. Not only do large annual rent Director Recovery Has Been Slow. California’s housing increases act as a signal to developers to build Deputy market is well into its third year of recovery more units, they can also indirectly affect the from the recent housing crisis, during which market for single-family homes. Specifically, as home prices declined substantially before hitting the cost to rent increases more quickly than the bottom in 2009. (The median cost to own, many current renters may find that existing single-family home price fell from $560,000 in Figure 5 2007 to $275,000 in 2009.) Home Prices Now Recovering After Steep Decline The recovery has been S&P/Case-Shiller Price Index of Existing Homes, Indexed to 100 in 2000 anything but stable, marked instead by a series of false 300 starts. Beginning in late Los Angeles San Diego 2009, for example, home 250 San Francisco prices in the state’s most populous areas—as shown in 200 Figure 5—made solid gains for nine consecutive months 150 before reversing trend throughout 2010 and 2011. 100 Construction activity also 50 suffered during the housing crisis, coming to a near halt in 2009. As shown in Figure 6 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 (see next page), single- and 15 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #120534 California’s Fiscal Outlook is has become comparably more affordable to property values and property taxes, which is purchase a home, further bolstering the modest discussed in the nearby box. housing recovery. Finally, a recent jump in the number of building permits—an indicator of Considerable Uncertainty Due to Difficulties future housing activity—suggests that housing in Forecasting Housing Trends. Forecasting development may already be responding to housing activity is difficult because housing is recent demand indicators. influenced by complex and often unpredictable economic relationships. These include broad Current Forecast Projects Recent Strength indicators like income and employment growth; to Continue. We view the trends discussed real estate metrics like credit availability, above as potentially more sustainable than those mortgage rates, affordability, and prices (which associated with earlier signs of housing strength, may be subject to speculation); as well as which proved largely illusory. Accordingly, we behavioral markers like household formation now forecast housing activity in the state to build and consumer confidence. In addition, the upon current trends and stabilize in the final most recent data used in most economists’ years of our forecast at approximately 160,000 forecast models—including our own—are from Graphic Sign Off new units annually, as shown in Figure 6. We two atypical periods: the housing boom of the forecast growth in both single- and multi-family mid-2000s aSnde cthree teanrsyuing crisis of the past few unit building activity. Although our forecast level years. Forecasting future housing activity relies Analyst of building permits is much lower than during heavily, therefore, on judgment and is prone to Director the housing boom of the mid-2000s, it remains significant upward and downward variation. a substantive upward adjustment in this forecast Because of thDee ipmuptoyrtance of the housing market compared to our previous projections. This to the state’s economy, housing activity below strength carries over to our forecast for assessed the levels in our forecast would in turn influence other key economic variables. For example, should building permits peak at 120,000 units Figure 6 annually (somewhat below California Building Activity Is Forecast to Recover our expectation of 160,000 Annual Residential Building Permits (In Thousands) units), the state’s sales tax base could grow about 160 one-half of a percentage Forecast 140 point slower each year Single-Family Permits through 2017-18 than our Multi-Family Permits 120 current forecast assumes. Construction employment 100 and, therefore, income taxes 80 also would be affected. 60 Federal Policy As noted in Chapter 1, the 40 fiscal cliff is a key uncertainty 20 in this forecast. All economic and tax forecasts are based 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 on assumptions about future 16 www.lao.ca.gov Legislative Analyst’s Office ARTWORK #120534 California’s Fiscal Outlook federal tax, spending, and regulatory policies. are scheduled to rise in 2013—potentially Similar to recent forecasts from our office, the increasing tax liabilities of about 90 percent of administration, and many economists, this the population. The following tax increases (or forecast assumes that the President and the end to temporary tax reductions) are scheduled Congress agree to actions in the coming weeks to to occur as part of the fiscal cliff: delay or eliminate the tax increases and spending cuts of the fiscal cliff in the near term. We believe • The end of the “Bush tax cuts” (which this is the most likely type of outcome. were extended during the Obama admin- istration), resulting in increased federal Tax Policy Issues Are the Key Short-Term income tax rates for the vast majority of Risk for the State Budget. We believe that the all taxpayers and a variety of other tax most significant fiscal cliff issues affecting the changes. Among the tax changes are higher state budget in the near term are the tax policy capital gains and dividend tax rates for decisions facing the President and the Congress. many taxpayers. Under current federal law, many federal taxes Assessed Property Values Projected to Improve Local Property Taxes Affect State Budget. Although property taxes are a local revenue source, our office forecasts statewide property tax revenue because the portion of these taxes that goes to school districts generally offsets—on a dollar-for-dollar basis—state General Fund spending on schools and community colleges. Statewide Assessed Value Set to Improve. We expect net assessed property value in the state to increase 1.7 percent to $4.4 trillion in 2012-13. (Net statewide assessed value is the main determinant of property tax revenue and consists of the combined taxable value of all property in California.) For 2013-14, we project statewide assessed value to strengthen further, consistent with recent trends in the state’s housing markets, increasing 3.7 percent to $4.6 trillion. Over the final four years of our forecast, assessed value increases by an average of about 5 percent per year. This growth is based on the projected recovery in building activity and home values, as well as the general economic expansion that is assumed to continue in our forecast through 2018. Property Taxes Available for School Districts Expected to Grow Faster Than Assessed Value. We expect local property taxes that go to K-12 and community college districts— revenues that generally offset state spending—to grow faster than statewide assessed value, for two reasons. First, local school property taxes benefit in the near term due to the dissolution of redevelopment agencies (RDAs) because a portion of property taxes that went to these agencies in recent years is now distributed to other local governments, including schools and community colleges. (The dissolution of RDAs is discussed in Chapter 3 of this report.) Second, the expected retirement of the state’s 2004 economic recovery bonds in 2016-17 increases local property taxes available for schools in the final years of our forecast by about $400 million per quarter. Because of these two factors, we expect property taxes for school and community college districts to grow at an average annual rate of over 6 percent between 2013-14 and 2017-18, notably faster than the growth in assessed value (about 5 percent annually) over the same period. 17 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook • The expiration of the 2 percentage point • A resumption of pre-2000 federal estate tax reduction in Social Security payroll taxes rates and exemption amounts, which could in effect for the last two years—increasing result in the number of estates subject to the taxes of about 120 million households. this tax increasing by more than ten times. • Increased applicability of the federal alter- In addition to the tax increases, a broad array native minimum tax (AMT)—potentially of domestic and defense-related spending cuts— affecting tens of millions of taxpayers some of which are to be implemented via the nationwide—in the coming months due federal government’s “sequestration” process— to the fact that there has not yet been an are scheduled to begin in 2013. (These would AMT “patch” passed for 2012. (Taxpayers impose on many programs an across-the-board in states with relatively high state or local spending cut—generally between 8 percent and taxes—such as New York, New Jersey, and 10 percent—but would not directly affect most California—may be the most likely to be of the major federal funding streams that flow affected if there is no AMT patch.) through the state treasury.) Extended emergency unemployment insurance (UI) benefits also • An additional 0.9 percent tax on higher- are scheduled to expire, which would shorten income taxpayers’ earnings and a new significantly the amount of time that some 3.8 percent investment surtax on higher- unemployed workers are eligible for benefits. income taxpayers’ capital gains, dividend, and interest income over certain thresholds, Forecast Assumes That Washington Avoids among other tax changes included in the the Fiscal Cliff. As noted above, our economic Patient Protection and Affordable Care Act and budgetary forecast assumes that the (the federal health care reform law). President and the Congress adopt measures in the next few weeks to delay or eliminate virtually • The expiration of several expanded tax all of the near-term tax increases and spending credits for low-income households adopted cuts of the fiscal cliff. Instead, we assume that during the Obama administration, such federal officials eventually reach agreements as the expansion of the earned income tax that involve spending cuts and tax increases, credit adopted as part of the 2009 federal phased in over many years, to address the federal stimulus package. government’s serious long-term budgetary challenges. Our forecast also assumes that the • The expiration of various other short-term necessary increase in the federal debt ceiling tax provisions that Congress regularly in 2013 causes little or no disruption to the extends (known as “extenders”), such as the economy, including consumer confidence. adoption credit, the deduction for qualified education expenses, and the research and Recession Likely if Federal Leaders Are experimentation business tax credit. Deadlocked. If the President and the Congress cannot come to an agreement and the fiscal cliff • The end to the temporary “bonus depre- tax increases go into effect (particularly when ciation” business tax provision for new combined with the domestic and defense federal investments, which has allowed companies spending cuts in the current sequestration law), to expense more costs of qualified the U.S. economy likely would fall into recession machinery and equipment, rather than in 2013. This in turn would cause the California claiming deductions for depreciation over economy to perform considerably weaker than time. 18 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook we assume in our forecast and reduce state 2.2 percent on a year-over-year basis, while revenues substantially in the near term. In an exports to Europe have been down recently— alternative simulation in which we assumed both figures related to the weakened economies a 0.6 percent contraction of real U.S. GDP in of those important trading partners. Our 2013—rather than the 1.8 percent increase in our forecast assumes that business investments in forecast—state revenues in 2012-13 and 2013-14 structures, equipment, and software are now combined were about $11 billion lower than growing more slowly than before—a trend that indicated in our forecast. (For the state’s General could affect California’s technology and service Fund expenditures, such a revenue reduction sectors in the coming months. In general, would be accompanied by a lower Proposition 98 uncertainty about federal tax and spending minimum guarantee and higher spending policy inhibits risk taking and causes businesses requirements under current law for various and consumers to be more cautious in their health and social services programs.) The bulk spending and investment decisions. While of the assumed drop in GDP in this alternative there are “downside” risks due to the fiscal cliff, recession scenario results from the expiration we note as well that there are “upside” risks to of the Bush tax cuts and the payroll tax cut. our economic forecast. If, for example, there is Spending cuts, the end of the bonus depreciation a speedy agreement concerning these federal policy, and the expiration of emergency UI issues, this could be looked upon favorably by benefits each are responsible for a smaller consumers and businesses, thereby encouraging part of this hypothetical near-term economic them to spend, invest, and hire even more in the contraction. short term than we are projecting. Policy Uncertainty Hindering U.S. and Global Economic Growth. The perception of The deMOgrAPhIC political paralysis concerning economic policy in the U.S., Europe, and China has constrained OuTLOOk global economic growth in recent months. These issues contribute to our weaker projections Domestic and International Migration for near-term U.S. economic growth. Exports Expected to Climb. A summary of the key and business fixed investment had—until findings of our California population forecast recently—been key drivers of the current global is shown in Figure 7. Over the next several economic recovery, but U.S. export growth has years, we project steady overall growth in the slowed. Exports to China are growing at only state’s population of about 1 percent per year. Figure 7 LAO California Population Forecast (In Thousands) 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Population (as of July 1) 37,077 37,318 37,639 38,004 38,414 38,849 39,305 39,727 40,133 40,541 Percent change from prior year 0.6% 0.7% 0.9% 1.0% 1.1% 1.1% 1.2% 1.1% 1.0% 1.0% Births 527 510 507 511 516 522 528 534 538 542 Deaths 220 229 231 234 237 239 242 245 248 251 Net domestic migration -144 -133 -87 -61 -27 -3 13 -19 -31 -31 Net international migration 58 94 128 149 157 155 157 151 147 147 19 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook Migration into California—from other states and In the next few years, the number of Hispanic countries—declines during periods of relative Californians should surpass the number of economic weakness here. As Figure 7 shows, we non-Hispanic white residents. In 2020, we project estimate that the state has recently experienced that Hispanics will comprise 39 percent of the significant declines in domestic migration state’s population, followed by non-Hispanic (that is, many more people have left California whites (37 percent), Asian Americans for other states than have come from other (14 percent), African Americans (6 percent), and states). Our forecast projects that these trends other racial and ethnic groups (4 percent). are turning around, and total net migration (domestic and international) will be positive over the forecast period. The state’s population—now reVeNue OuTLOOk just over 38 million—is projected to surpass 40 million in 2017. Figure 8 shows our multiyear forecast of General Fund and Education Protection Our forecast assumes continued declines in Account (EPA) revenues, including revenues both birth rates and death rates. Specifically, resulting from the two tax-related measures women are waiting until later to have children that voters approved at the statewide election and are having fewer children, on average, than on November 6, 2012. These two measures are in the past. This trend is largely responsible for a Proposition 30 (which increases personal income projected small decline in the state’s school-age tax [PIT] rates for higher-income Californians and college-age populations between the 2010 through 2018 and raises the sales and use tax and 2020 censuses. We forecast that there will [SUT] rates by 0.25 percentage points for four be 6.7 million Californians age 5-17 in 2020 years beginning in 2013) and Proposition 39 (down 1.4 percent from 2010) and 3.8 million (which institutes a new corporation tax [CT] who are age 18-24 (down 2.8 percent from apportionment policy that will result in some 2010). In addition, Californians are living businesses paying more in taxes). longer and this—coupled with the aging of the massive post-World War II “baby boom” Figure 9 compares our revenue forecast for generation—is resulting in large increases in the 2011-12 and 2012-13 to other recent forecasts. elderly population. We forecast that there will be (Additional figures comparing this forecast with 6.5 million Californians age 65 and over in 2020 other recent forecasts are available on our website.) (up 51 percent from 2010). Personal Income Tax California’s Racial and Ethnic Makeup Little Net Change in Budget Act Revenue Continues to Change. In 1980, about 67 percent Assumptions. Before considering the passage of Californians were non-Hispanic whites, and of Proposition 30, which will generate some about 19 percent were Hispanic. By 2010, the revenue that the state plans to attribute—or census indicated that 40 percent of the state’s “accrue”—to 2011-12, PIT revenues for the population consisted of non-Hispanic whites, prior fiscal year currently are estimated to have and Hispanics made up 38 percent of the been $50.4 billion. After including our current population. During the same time period, Asian projections for Proposition 30 collections, Americans climbed from 5 percent to 13 percent we now estimate that 2011-12 General Fund of the population. African Americans made up and EPA PIT revenues will total $53.2 billion, 6 percent of the population in 2010, down from $255 million above the level assumed in the 7.5 percent in 1980. 2012-13 budget package. In 2012-13, we project 20 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook Figure 8 LAO November 2012 Revenue Forecasta General Fund and Education Protection Account Combined (In Millions) 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Personal income tax $53,213 $59,860 $61,712 $66,848 $71,602 $75,678 $79,786 Sales and use tax 18,859 20,839 22,721 24,354 25,993 26,835 27,214 Corporation tax 7,603 8,535 9,119 9,236 9,734 9,935 9,979 Subtotal, “Big Three” Taxes ($79,675) ($89,234) ($93,551) ($100,438) ($107,329) ($112,448) ($116,979) Insurance tax $2,204 $2,050 $2,187 $2,415 $2,492 $2,576 $2,667 Other revenuesb 2,819 2,695 2,129 2,071 2,103 2,034 2,069 Net transfers and loansc 1,784 1,631 -1,149 -622 -941 -638 -134 Total Revenues and Transfers $86,482 $95,610 $96,743 $104,332 $111,017 $116,461 $121,627 a Includes additional revenues from approval of Propositions 30 and 39 at the November 2012 statewide election. b Includes no estate tax revenues, given what we assess as a low likelihood that anticipated future federal legislation will include provisions allowing resumption of California’s state-level estate tax. If the current-law estate tax were to resume, it could generate a few hundred million dollars of 2013-14 revenue and over $1 billion per year by 2017-18. Exact dollar amounts would vary based on details of the future federal legislation related to the tax. c Reflects various transfers, including transfers to the Clean Energy Job Creation Fund required by Proposition 39 for five fiscal years beginning in 2013-14. Generally reflects actual or projected dates for repayment of loans to special funds listed in a July 30, 2012 report from the Department of Finance. Does not reflect any transfers to the Budget Stabilization Account under Proposition 58 (March 2004). PIT revenues to reach $59.9 billion, $408 million a large, volatile revenue source, this is a minor below the level assumed in the 2012-13 budget forecasting difference. package. Therefore, for the two fiscal years combined, our PIT forecast is $153 million below The over $6.6 billion of year-to-year the level assumed in the budget plan. For such growth between 2011-12 and 2012-13 is due to Figure 9 Comparisons With Prior Revenue Forecastsa General Fund and Education Protection Account Combined (In Millions) 2011-12 2012-13 LAO LAO LAO Budget Act November LAO Budget Act November May 2012 June 2012 2012 May 2012 June 2012 2012 Personal income tax $52,366 $52,958 $53,213 $59,368 $60,268 $59,860 Sales and use tax 18,927 18,921 18,859 20,765 20,605 20,839 Corporation tax 8,623 8,208 7,603 8,869 8,488 8,535 Subtotals, “Big Three” Taxes ($79,916) ($80,087) ($79,675) ($89,003) ($89,361) ($89,234) Insurance tax $2,150 $2,148 $2,204 $2,093 $2,089 $2,050 Other revenues 2,800 2,810 2,819 2,712 2,849 2,695 Net transfers and loans 1,784 1,784 1,784 1,489 1,588 1,631 Total Revenues and Transfers $86,650 $86,830 $86,482 $95,297 $95,887 $95,610 Difference—LAO November Forecast Minus Budget Act -$348 -$277 Difference—LAO November Forecast Minus LAO May Forecast -$169 $314 a Estimates include the effects of Proposition 30, which was approved by voters at the November 2012 statewide election. In addition, the LAO November 2012 forecast includes the 2012-13 effects of Proposition 39. 21 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook (1) a full fiscal year of increased revenue under grow to $774 billion (up 6 percent) in 2012. As Proposition 30, (2) assumed growth in the 2012 job growth in the state is faster than that in economy and stock market, and (3) 2012-13 2011, so is the growth in overall taxable wages. revenues related to Facebook, Inc.’s initial public (A small portion of this 2012 gain represents offering (IPO) of stock. taxable income that higher-income Californians, in particular, are projected to accelerate—that is, About 6 Percent Annual Growth in PIT choose to receive early—in order to benefit from Revenues Forecast. For 2013-14, we forecast lower federal tax rates in current law before the General Fund and EPA PIT revenue to grow scheduled fiscal cliff tax increases.) to $61.7 billion, with steady growth thereafter, reaching $79.8 billion in 2017-18. Between Our forecast model assumes that California 2012-13 and 2017-18, we forecast average annual resident tax filers’ wage and salary income growth in PIT collections of 5.9 percent. surpasses $1 trillion for the first time in 2017. Between 2012 and 2018, we assume that wages Strengthening Job Market Helps PIT and salaries for all resident California taxpayers Revenues. The PIT is the state’s largest General grow at an average annual rate of about Fund revenue source and grows over time 5 percent—similar to the growth rate in recent largely in line with the main component decades. Employment growth, inflation, and of taxable personal income: the wages and changes in labor productivity contribute to rising salaries of Californians. The most recent data wages and salaries throughout the economy. for 2010 indicate that wages and salaries made up 73 percent of California resident tax filers’ Capital Gains Drive PIT Volatility. Net adjusted gross income (AGI) and accounted capital gains made up only 6 percent of AGI in for 63 percent of PIT revenue. Accordingly, the 2010 and 3 percent in 2009, but this relatively strength of trends in the state’s job market plays a small part of overall income is the most difficult major role in the PIT’s overall growth rate. element of the PIT to project. Net capital gains—the difference between capital gains and Consistent with the decline in employment capital losses reported on tax returns—represent in the state during 2008 and 2009 (illustrated net investment gains from sales of assets such earlier in this chapter in Figure 4), resident tax as stocks, bonds, and real estate. Data suggest filers saw their wage and salary income drop that the single greatest driver of capital gains from $716 billion in 2008 to $679 billion in trends is the direction of the stock market. All 2009 (down 5.2 percent). In 2010, wages and economic models must make assumptions about salaries grew to $697 billion (up 2.7 percent). stock market trends, as does ours. Nevertheless, The Franchise Tax Board (FTB) will provide in any given time period, the stock market can us with our first solid data on 2011 wages later move up or down in ways that are both wildly this month, but based on 2011 and 2012 PIT volatile and inconsistent with trends elsewhere in collections, economic data, and our forecasting the economy. As such, capital gains forecasts are estimates, we currently assume that wages subject to a wide band of uncertainty. and salaries grew to about $730 billion (up 4.6 percent) in 2011. The significantly greater While capital gains made up 6 percent of increase in wages and salaries in 2011 was driven AGI in California in 2010, personal income taxes by the start of the state’s job recovery in that year. paid on these capital gains totaled 10.5 percent of overall PIT paid that year, according to FTB Furthermore, based on data received to date estimates. The typical dollar of capital gains is for 2012, we assume that wages and salaries will taxed at a higher rate than the typical dollar of 22 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook wage and salary income. In 2010, 15 percent can easily cause actual PIT revenues to be a few of total AGI was reported on tax returns that billion dollars lower or higher than projections in had AGIs of $1 million or greater. By contrast, any given year. over 75 percent of capital gains were reported on returns with taxable income of $1 million Facebook Stock Slump Offsets Other or greater. Returns with $10 million or more of Projected PIT Gains. The May 2012 IPO taxable income had 46 percent of all capital gains. of stock by Facebook, Inc. was plagued by Net capital gains reported by resident tax Figure 10 filers climbed as high as $120 billion in 2000 (equal to 10.6 percent of personal income) and Capital Gains Assumed to $132 billion in 2007 (8.4 percent of personal Rise in Forecast income), as shown in Figure 10. Such increases (Dollars in Billions) were driven by “asset bubbles” in the stock California As Percent of market and/or the real estate market. Net capital Residents— Personal gains fell to $29 billion in 2009 (1.9 percent of Tax Year Net Capital Gains Income personal income) before rising, along with the 1990 $22 3.5% recovery in the stock market, to $55 billion in 1991 17 2.6 2010 (3.5 percent of personal income). While 1992 17 2.5 the stock market has grown fairly well during 1993 20 2.7 much of the time since then, we assume that net 1994 18 2.5 1995 21 2.7 capital gains remained fairly flat in 2011, given 1996 33 4.0 the substantial losses that investors experienced 1997 47 5.4 during the recession (which “offset” the gains 1998 61 6.4 that they report). Figure 10 shows our forecast 1999 94 9.2 for net capital gains, including gains assumed to 2000 120 10.6 be accelerated from 2013 to 2012 due to the lower 2001 49 4.2 federal tax rates currently in federal law prior to 2002 33 2.8 2003 46 3.7 the fiscal cliff. 2004 75 5.8 2005 113 8.1 Volatility Likely to Increase Due to 2006 118 7.9 Proposition 30. As described above, the volatility 2007 132 8.4 in the stock market will contribute to PIT 2008 56 3.5 revenues being lower or higher than reflected 2009 29 1.9 in our forecast in each fiscal year. Because 2010 55 3.5 2011a 55 3.4 Proposition 30 increases the dependence of the 2012a,b 93 5.4 state budget on revenues paid by higher-income 2013a,b 68 3.8 taxpayers, who receive most capital gains, it 2014a 89 4.7 is likely to increase the volatility of revenues 2015a 95 4.7 through 2018. Also, as we noted in the November 2016a 99 4.7 2012 Voter Information Guide, uncertainty 2017a 104 4.7 concerning the responses of high-income 2018a 109 4.7 a taxpayers to Proposition 30’s income tax Forecast. For 2012 and beyond, assumes steadily increasing stock market prices. increases may make these new revenues b Assumes that 20 percent of capital gains that otherwise would be particularly difficult to estimate. These issues realized in 2013 are accelerated to 2012 due to lower current-law federal tax rates. 23 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook technical mishaps and other concerns, and the expect SUT receipts to increase 10.5 percent to company’s stock prices lagged far below budget $20.8 billion ($234 million above the 2012-13 act assumptions in the ensuing months. This budget assumption). The growth in 2012-13 is the forecast assumes the state’s IPO-related General result of (1) the temporary one-quarter cent SUT Fund revenues total $1.25 billion in 2011-12 and increase under Proposition 30 and (2) growth 2012-13 combined—down from the $1.9 billion in underlying taxable sales. (Proposition 30 assumption in the budget act. While taxpayer increases the statewide SUT for four calendar confidentiality laws mean that there never will years—2013 through 2016—meaning that it be a precise estimate of this total, sharp increases affects half of fiscal year 2012-13 and all of in daily state tax collections following both 2013-14.) For 2013-14, we forecast SUT revenue the IPO and the settlement of restricted stock to increase 9 percent to $22.7 billion. The SUT units (RSUs) by Facebook employees—as well revenues then grow more modestly—at an as Facebook’s public filings—suggest that most annual rate of 4.6 percent over the final four of this amount already has been collected by the years of our forecast. The slower growth in state. Other revenues are likely to be collected in SUT receipts in the out-years also reflects the conjunction with future RSU settlement activity, expiration of the temporary rate increase. estimated tax payments, final returns, and tax extension payments. We also assume that 2013-14 Trends in Taxable Sales. The main General Fund revenues related to the IPO will be determinant of SUT receipts is taxable sales—the $310 million. amount spent by individuals and businesses on goods that are subject to the SUT. Significant Our forecast of 2011-12 and 2012-13 PIT components of General Fund taxable sales revenues not related to the IPO are higher than include vehicle sales (9 percent of taxable sales), those assumed in the budget act and in our construction materials used to build residential office’s May Revision revenue forecast. Compared and commercial properties (6 percent), and to the budget act PIT assumptions, our projected consumer spending on dining (12 percent), increase in non-IPO PIT revenues ($473 million electronics (3 percent), and furniture (2 percent). for the two fiscal years combined) mostly offsets About two-thirds of taxable sales are consumer our projected decrease in IPO-related PIT spending, whereas the remainder is business- revenues ($626 million). to-business transactions where the purchasing business is the final user of the product. Given that future IPO-related tax collections (Business purchases that become part of a final will simply be “lumped in” with other PIT product are not subject to the sales tax.) collections, this likely will be the last time that we are able to estimate specific, discrete numbers Consumer and business spending on taxable for Facebook IPO-related revenues. In the future, items declined 14 percent in 2009, as income IPO-related RSU settlements and options also levels fell, savings rates climbed, and economic will be lumped in with other official economic uncertainty shattered consumer confidence. As data, such as personal income data released by shown in Figure 11, however, taxable activity— the federal government. measured by taxable sales as a share of personal income—has recovered strongly, in part because sales and use Tax consumers and businesses are now making Estimated SUT revenue totaled $18.9 billion large purchases that were postponed during in 2011-12, $62 million lower than the amount the recession. We expect the recent increase in assumed in the 2012-13 budget. In 2012-13, we taxable sales as a share of personal income to 24 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook moderate throughout the rest of our forecast as projection would have been $403 million short businesses and consumers normalize spending of the budget act forecast. Below, we discuss patterns. possible reasons for this weakness in baseline CT revenues. Our forecast further reflects the Optimism Concerning New Vehicle Sales assumption that CT revenue will grow from and Housing Activity. Our current forecast of $8.5 billion in 2012-13 to $10 billion in 2017-18— taxable sales is slightly stronger than our most an average annual growth rate of 3.2 percent recent forecast, developed for the May Revision. during that time period. (About one-third of this This improvement reflects a more optimistic growth is attributable solely to Proposition 39, outlook for new vehicle sales and housing activity given that the half-year revenue effect in 2012-13 over the next five years, an outlook supported grows to a full-year revenue effect in 2013-14 and by recent economic reports. For example, new beyond. If Proposition 39 had not passed, the vehicle sales increased 35 percent in the third growth rate would be a much weaker 2 percent quarter of 2012 (from levels a year earlier) and per year.) the S&P/Case-Shiller Index of housing prices has seen consistent gains throughout 2012. National Corporate Profit Data Was Graphic Sign Off Increasing home prices and monthly rents tends Revised Downward. The vast majority of to spur construction activity as developers California CT revenue is paid by multistate Secretary build additional units to meet rising housing and multinational corporations that apportion Analyst demand. We expect these trends to continue, (allocate) a share of their profits to California. Director especially given the improved outlook that many The 2012-13 Budget Act was premised on an consumers have about the economy. In October, assumption that national corporate profits hDade puty for example, the Reuters/University of Michigan grown from $1.4 trillion in 2009 to $1.8 trillion Consumer Sentiment Index rose to 82.6 points, in 2010—a 32 percent increase. (Our office’s its highest level since the recession began. Figure 11 Taxable Sales Are Forecast to Grow Corporation Tax Modestly as a Share of Personal Income Estimated CT revenue totaled $7.6 billion in 38% 2011-12, $605 million below the 2012-13 budget act 36 assumption. We forecast Forecast that General Fund CT 34 revenue will be $8.5 billion in 2012-13, $47 million above 32 the budget assumption. This 2012-13 forecast—unlike the 30 budget act forecast—includes additional revenue projected 28 to be raised under the new mandatory single sales factor 26 provisions of Proposition 39. If Proposition 39 had not 24 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 passed, our 2012-13 CT 25 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #120534 California’s Fiscal Outlook May Revision estimates were based on a similar part of a single business group for tax purposes. forecast for 2010.) In August, the federal Bureau In total, the major changes to CT policies likely of Economic Analysis revised the 2010 national are reducing General Fund revenues by over corporate profits figure down to $1.7 trillion—a $2 billion per year, as of 2012. 27 percent increase over revised 2009 figures. This data revision results in our current forecast Proposition 39 Increases CT Revenues. for national profits being about $100 billion Proposition 39—which will affect corporations’ less in each year compared to the economic 2013 and subsequent tax returns—partially forecast upon which the budget act was based. reverses the recent policy trend of reducing CT (The revision also may help explain part of the revenues. Proposition 39 eliminates the elective reason why CT revenues have fallen so far short single sales factor policy now in effect and of state projections over the past year.) replaces it with a requirement for most multistate corporations to apportion profits to California Flat Corporate Profits Projected. Similar to based on the single sales factor method. This our recent forecasts, we assume weaker national will result in some corporations paying higher profit growth in later years. We now assume taxes resulting in projected half-year revenues profits remain relatively flat over the forecast of $450 million in 2012-13 and an estimated period. Recent profit gains likely were the result $1 billion per year thereafter. For the five fiscal of the “bounce back” after the recession and years 2013-14 through 2017-18, however, the cost cutting, including flexibility in labor costs. proposition dedicates half of the revenues—up to Some corporations also have benefited from $550 million annually—for clean energy projects. low borrowing costs, which, like labor costs, are (This latter portion of Proposition 39 revenues likely to rise as the economy gains strength. is not included in Proposition 98 revenue calculations in our forecast.) Recent Tax Policy Changes Have Reduced CT Revenues. As we described in our February Recent Policy Changes Complicate 2012 publication, The 2012-13 Budget: Economic Forecasting Significantly. Our revenue and Revenue Update, the state has undertaken forecasting models use statistical tools to a variety of corporate tax policy actions in identify relationships between economic and recent years. Collectively, the effect of several tax data in the past and then forecast how of the state’s policy actions was to accelerate those relationships will play out in the future. CT collections from 2011 and beyond back These tools work best in a stable tax policy to 2007-08, 2008-09, and 2009-10 in order to environment. Recent weakness in CT revenues— help the state’s budget situation during the potentially related to recent policy changes—has recession. These policy changes appear now been so significant that our confidence in to be reducing CT revenues, as intended. The standard forecasting models has declined. As policy actions included the suspension, for with the PIT, additional data on recent years’ CT 2008 through 2011, of larger businesses’ use collections will be available from FTB later this of net operating loss deductions. In addition month. It probably will take several more years— to these accelerations of CT revenue, the state assuming a stable policy environment in the also changed corporate tax policies in order future—in order to recalibrate and improve our to reduce taxes for some businesses—such as forecasting models in light of the new policies the adoption of the elective single sales factor in place. The CT has always been a difficult tax method of profit apportionment and allowing the to forecast, with many factors influencing the transfer of credits among companies treated as amount of taxes businesses owe the state in any 26 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook given year. It will remain much more difficult to state has lent balances of its special funds to forecast than usual for a few more years. the General Fund in order to address budget shortfalls over the last decade. When the General estate Tax Fund is directed to repay such a loan, this is Federal Actions Necessary to Resume State booked as a transfer out of (a “negative” transfer Tax Are Very Unlikely to Occur. In 2001, as a from) the General Fund—for the repayment of part of the tax reductions enacted during the principal. (The state also incurs expenditures to Bush administration, the federal government pay interest on these loans—generally linked to adopted reductions over several years to its estate a measure of what the special fund otherwise tax and eliminated a tax code provision known would have earned in interest in the state specifically in state and federal law as the “Credit investment pool.) In effect, such transfers out for State Death Taxes.” The state credit was reduce overall General Fund revenues in the eliminated entirely for estates of those dying after state’s budgetary accounting system. Figure 8— December 31, 2004. In 2010, the Congress and earlier in this chapter—shows projected net President Obama agreed to extend the temporary transfers and loans in each fiscal year, including 2001 estate tax legislation—including elimination special fund loan repayments. of the state death tax credit—until the end of 2012. Under current federal law, therefore, In July 2012, DOF reported that the General the pre–2001 estate tax regime will resume at Fund owed $3.6 billion in loan principal the beginning of 2013 (part of the fiscal cliff), repayments to special funds. Given another including the state credit. $713 million of new loans authorized in the 2012-13 budget plan, the General Fund now has Most observers believe that, no matter what $4.3 billion of outstanding budgetary loans from Congress does to the estate tax in the coming the state’s special funds. (These loans were one of months, there will no longer be a credit for state- the components of the Governor’s “wall of debt” level estate taxes. Our forecast assumes that this listing.) consensus is correct. Pursuant to Proposition 6 (1982), the state may only collect estate taxes Forecast Assumes Loans Repaid Pursuant equal to the Credit for State Death Taxes in to Schedule Provided by Administration. The federal law. Accordingly, our forecast assumes July DOF report included anticipated repayment that the state receives no estate taxes related to dates for many, but not all, outstanding General deaths that occur in the future. We again advise Fund loans (which sometimes were based on loan the Legislature to assume no such revenues repayment deadlines in prior budget acts). Our unless there is a clear indication from the forecast generally assumes that loans are repaid Congress that such a tax credit will be adopted. on the dates that DOF listed (as modified by the If our assumption is wrong, the amount of funds 2012-13 budget package in some cases), unless the state will collect will depend on the details we identified a specific reason why a special fund of whatever estate tax legislation is enacted at might need an earlier repayment. For example, the federal level. (These additional revenues, if Figure 12 (see next page) shows the special fund they were to be received, also would increase the loans assumed in our forecast to be repaid by the state’s Proposition 98 minimum guarantee.) end of 2013-14. In our forecast, the $4.3 billion balance described above is reduced to $3.1 billion Transfers by the end of 2013-14 and $1.2 billion by the General Fund’s Budgetary Loans From end of 2017-18. (The $1.2 billion of remaining Special Funds Now Total $4.3 Billion. The loans is assumed to be paid after 2017-18 in 27 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook our forecast, since the DOF report includes no Recycling Fund—judges rejected claims from specific repayment dates for these.) Accordingly, litigants that these particular loans compromised to achieve the Governor’s stated goal of paying special fund purposes or transformed regulatory down entirely this element of the wall of debt processing fees into taxes (which arguably within the next few years, additional loan might have required a two-thirds vote of the repayments—above the level included in our Legislature). In one of the cases, the court stated forecast—would be required. that allowing the special fund loans to remain in place was a “reasonable and practical result that Legislature Has Considerable Flexibility gives the state flexibility to balance its budget Concerning Loans Under Recent Case Law. The in a manner that does not stymie beneficial increased prevalence of special fund budgetary regulation.” We read these decisions to give the loans to the General Fund has been the subject Legislature considerable, continuing flexibility of recent litigation. In two 2011 appellate court related to special fund budgetary loans. At cases—concerning loans to the General Fund the same time, the decisions suggest that the from the Contingent Fund of the Medical Legislature has some measure of responsibility Board of California and the Beverage Container to ensure that special fund programs adequately meet the responsibilities Figure 12 for which the funds’ Special Fund Loans Assumed to Be Repaid in revenues were levied in 2012-13 and 2013-14 the first place. (In Millions) Amount Fund Name Outstanding State Highway Account, State Transportation Fund $200.0 National Mortgage Special Deposit Fund 100.0 California Beverage Container Recycling Fund 99.4 Immediate and Critical Needs Account (Judicial Branch)a 90.0 California Advanced Services Fund (PUC) 75.0 High-Cost Fund-B Administrative Committee Fund (PUC) 75.0 Hospital Building Fund 75.0 Renewable Resource Trust Fund 65.9 Occupancy Compliance Monitoring Account (CTCAC) 57.0 Tax Credit Allocation Fee Account (CTCAC) 48.0 Enhanced Fleet Modernization Subaccount, High Polluter 40.0 Repair or Removal Account Oil Spill Response Trust Fund 40.0 Glass Processing Fee Account 39.0 State Emergency Telephone Number Account 28.0 California Tire Recycling Management Fund 27.1 Electronic Waste Recovery and Recycling Account 27.0 PET Processing Fee Account, California Beverage Container 27.0 Recycling Fund All others 146.4 Total $1,259.8 a Based on LAO assessment of cash flow needs. Other loan repayments based on Department of Finance report dated July 30, 2012 and loan extensions in 2012-13 budget. CTCAC = California Tax Credit Allocation Committee; PUC = Public Utilities Commission; PET = polyethylene terephthalate. 28 www.lao.ca.gov Legislative Analyst’s Office Chapter 3 Expenditure Projections In this chapter, we discuss our expenditure spending will increase an average of 3.6 percent estimates for 2011-12 and 2012-13, as well annually between 2012-13 and 2017-18. Growth as our projections for 2013-14 through in Medi-Cal (6.8 percent) drives this increase, 2017-18—both for the General Fund and while growth in Cal Grants and debt-service the Education Protection Account (EPA) costs (12.6 percent and 7.8 percent over the created by Proposition 30. Figure 1 (see next forecast period, respectively) also contribute page) shows our projections of General Fund significantly. General Fund expenditures to expenditures for major programs. Below, we fund the judicial branch are assumed to grow discuss estimated General Fund spending for by 10.7 percent over the forecast period—almost 2012-13 and expenditure trends in the forecast entirely the result of other revenues replacing period. Thereafter, we discuss our expenditure General Fund support in 2012-13. Caseload projections for individual program areas. and prison population decreases contribute to declining spending in our forecast for California 2012-13 Outlook Work Opportunity and Responsibility to Kids We estimate that General Fund expenditures (CalWORKs) and the state’s prison system, in 2012-13 will total roughly $94 billion, about respectively. (In the latter instance, the data 7.9 percent higher than in 2011-12. Higher in the figure for the California Department Proposition 98 spending—in part due to the of Corrections and Rehabilitation [CDCR] passage of Proposition 30 and the resulting does not consider already-negotiated pay and increase in the minimum guarantee—and other compensation changes for some CDCR repayment of the Proposition 1A loan account employees, which are included as a separate item for most of this change. We estimate that under “Other programs/costs.”) General Fund expenditures in 2012-13 will be about 2.9 percent higher than the amount assumed in the 2012-13 budget package, largely eduCATION due to lower-than-expected savings related to the dissolution of redevelopment agencies Overview of State Funding for Education. (discussed later in this chapter). State funding supports preschool; elementary and secondary education (commonly referred to expenditure growth as K-12 education); the California Community during the Forecast Period Colleges; the California State University (CSU); Moderate Growth Beginning in 2012-13. the University of California (UC); Hastings Our forecast projects that General Fund Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook Figure 1 Projected General Fund Spending for Major Programs Includes Education Protection Account (Dollars in Millions) Average Annual Growth From Estimates Forecast 2012-13 to 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2017-18 Education K-14—Proposition 98 $33,089 $38,648 $40,470 $43,399 $45,797 $46,015 $46,848 3.9% QEIA payments — — 228 181 — — — — CSU 1,937 1,940 2,065 2,065 2,065 2,065 2,065 1.3 UC 2,072 2,166 2,291 2,291 2,291 2,291 2,291 1.1 Student Aid Commission 1,486 684 751 860 969 1,133 1,237 12.6 Child care 1,031 751 717 745 777 821 884 3.3 Health and Human Services Medi-Cal 15,461 14,581 15,746 17,116 17,837 18,918 20,285 6.8 CalWORKs 992 1,565 1,713 1,703 1,551 1,455 1,392 -2.3 SSI/SSP 2,720 2,770 2,827 2,886 2,945 3,006 3,069 2.1 IHSS 1,711 1,697 1,839 1,894 1,963 2,037 2,116 4.5 DDS 2,536 2,652 2,781 2,873 2,969 3,069 3,173 3.7 Department of State Hospitals 1,290 1,295 1,357 1,398 1,421 1,434 1,448 2.2 Other major programs 1,644 1,902 1,406 1,400 1,499 1,538 1,573 -3.7 Corrections and Rehabilitation 7,772 8,509 8,397 8,244 8,195 8,239 8,275 -0.6 Judiciary 1,226 726 1,192 1,209 1,208 1,208 1,209 10.7 Proposition 1A loan costs 91 2,095 — — — — — — Infrastructure debt servicea 5,097 5,025 5,825 6,436 6,785 7,090 7,328 7.8 Other programs/costs 6,926 6,945 8,074 8,188 8,457 8,644 8,854 5.0 Totals $87,082 $93,950 $97,679 $102,889 $106,728 $108,962 $112,047 3.6% Percent Change 7.9% 4.0% 5.3% 3.7% 2.1% 2.8% a Does not include General Fund debt-service costs of lease-revenue bonds funded through the California Community College portion of Proposition 98 funding. These costs total $64 million in 2012-13. QEIA = Quality Education Investment Act; IHSS = In-Home Supportive Services; and DDS = Department of Developmental Services. College of the Law; the Cal Grant program, the minimum guarantee. Both state General which provides students with financial aid to Fund (including EPA) and local property tax help with college costs; and subsidized child care revenue apply toward meeting the minimum for eligible low-income families. guarantee. In addition to Proposition 98 funding, schools and community colleges receive funding Proposition 98 from the federal government, other state sources (such as the lottery), and various local sources Proposition 98 “Minimum Guarantee” (such as contributions from community- for Schools and Community Colleges. State based organizations, fees for school meals and budgeting for schools and community colleges transportation, and parcel taxes). is governed largely by Proposition 98, passed by voters in 1988. The measure, modified by Calculating the Minimum Funding Proposition 111 in 1990, establishes a minimum Guarantee. The Proposition 98 minimum funding requirement, commonly referred to as 30 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook guarantee is determined by one of three tests Proposition 98 General Fund costs will be set forth in the State Constitution. These tests $1.6 billion higher in 2012-13 due to our revised are based on several inputs, including changes local property tax revenue estimates. (Lower in K-12 average daily attendance, per capita property tax revenues require the state to backfill personal income, and per capita General Fund schools and community colleges with additional revenue. Though the calculation of the minimum General Fund dollars.) As we discuss later in this guarantee is formula-driven, a supermajority report, our forecast assumes substantially less of the Legislature can vote to suspend the property tax revenue will be transferred to school formulas and provide less funding than the districts and community colleges from former formulas require. This happened in 2004-05 redevelopment agencies in 2012-13—$1.8 billion and 2010-11. In some cases, including as a result less than assumed in the adopted budget. of a suspension, the state creates an out-year These higher costs from lower-than-anticipated obligation referred to as a “maintenance factor.” redevelopment revenues are somewhat offset The state is required to make maintenance by higher estimates of baseline property tax factor payments when year-to-year growth in revenues (up by $184 million). state General Fund revenues is relatively strong, such that increases in education funding are Proposition 98 Forecast accelerated. Additional Funding in 2013-14, With Steady Increases Thereafter. As shown in Figure 2 (see Current-Year Proposition 98 Adjustments next page), we project Proposition 98 funding Minimum Guarantee $193 Million Above will be $55.8 billion in 2013-14—$2 billion higher Budget Estimates. Our revised current-year than the current-year level. In addition to this estimate of the minimum guarantee is growth, another $2.2 billion in ongoing funding $53.8 billion—$193 million higher than the would be freed up within the Proposition 98 guarantee as estimated at the time of budget base. This is because the 2012-13 budget plan enactment. The minimum guarantee changes as dedicated these funds to a one-time purpose a result both of updating revenue estimates and (paying down K-14 deferrals). As a result of the adding in the revenue generated by the passage growth in the guarantee and freed-up funding, a of Proposition 39, which raises corporation total of $4.2 billion in additional resources would tax revenues beginning in 2013. Our lower be available in 2013-14. In 2014-15 and 2015-16, projections of revenues decrease the minimum we project Proposition 98 increases of about guarantee by $249 million. This decrease is $3 billion annually. Increases would be more more than offset, however by an increase in the modest in 2016-17 and 2017-18, due in part to the minimum guarantee of $443 million due to the expiration of the temporary sales tax increases passage of Proposition 39 (reflecting virtually approved in Proposition 30. all of the revenue raised by the measure in the first half of 2013). Our forecast assumes the Major Proposition 98 Issues state appropriates an additional $193 million in Many Competing Spending Priorities. As the current year to meet the higher minimum described above, during the coming five years, guarantee. schools and community colleges are likely to experience significant increases in funding. Lower Estimates of Redevelopment Revenues In choosing how to allocate these funding Also Result in Higher General Fund Costs. In increases, the Legislature will face many addition to higher costs incurred due to the competing priorities. As shown in Figure 3 (see increase in the minimum guarantee, we estimate next page), the state has almost $13 billion in 31 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook Figure 2 Proposition 98 Forecast (Dollars in Millions) 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Minimum Guarantee General Fund $38,648 $40,470 $43,399 $45,797 $46,015 $46,848 Local property tax 15,140 15,303 15,314 16,053 18,300 19,684 Totals $53,788 $55,773 $58,713 $61,850 $64,316 $66,532 Year-to-Year Change in Guarantee Amount $6,872 $1,985 $2,940 $3,136 $2,466 $2,217 Percent change 14.6% 3.7% 5.3% 5.3% 4.0% 3.4% Maintenance Factor Obligations Maintenance factor created/paid (+/-) -$3,070 $350 -$1,220 -$517 $278 $457 Outstanding maintenance factor 7,732 8,417 7,517 7,336 7,940 8,726 Key Factors Operative Proposition 98 “Test” 1 3 2 2 3 3 K-12 average daily attendance 0.34% -0.07% -0.24% -0.13% 0.01% 0.01% Per capita personal income (Test 2) 3.77 4.34 3.80 4.60 4.43 4.15 Per capita General Fund (Test 3)a 10.94 3.69 6.67 6.04 3.98 3.44 K-14 COLAb 3.24 1.66 1.85 2.10 2.28 2.44 a The Test 3 factor consists of the year-to-year increase in per capita General Fund revenues plus 0.5 percent. b Does not affect calculation of minimum guarantee. COLA = cost-of-living adjustment. outstanding one-time education obligations. In up the base, the Legislature likely will want addition to retiring these one-time obligations, to weigh the trade-offs among: (1) restoring the Legislature will also be interested in prior-year base reductions; (2) making up building up base ongoing support for schools foregone cost-of-living adjustments (COLAs); and community colleges, particularly given (3) providing a budget-year COLA; (4) equalizing the cuts made to education programs in per-pupil funding; and (5) addressing the recent years. In considering how best to build end of “categorical flexibility” provisions, Figure 3 Paying Down One-Time Education Obligations Estimated 2012-13 Year-End Obligations (In Millions) Obligation Description Effect on Districts of Paying Down Amount Revenue limit/ Reflects late state payments for schools Benefits districts that rely more heavily $8,206 apportionment deferrals ($7.4 billion) and community colleges on state funding. ($801 million). Education mandates Reflects unpaid prior-year mandate claims for Benefits districts that participate in 4,115 schools ($3.8 billion) and community colleges state mandate reimbursement process ($355 million). and file relatively high-cost claims. Emergency Repair Funds school facility projects deemed critical Benefits certain low-performing 462 Program for ensuring public health and safety. schools. Total $12,783 32 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook including potentially transitioning to a new K-12 Legislature has many options to consider when weighted student formula. Whereas the state deciding how to allocate ongoing funding has made no statutory commitment to restore increases for schools and community colleges. base apportionment cuts or make up foregone The trade-offs entailed in choosing among all the COLAs for community colleges, it has created different options are important because different a corresponding statutory commitment for designations send different messages and have schools—known as the “revenue limit deficit different distributional effects on districts. factor.” Of the $9.2 billion revenue limit deficit For example, designating funds for restoring factor, $3.7 billion is associated with base prior-year cuts likely would result in many reductions in school funding and $5.5 billion districts hiring additional staff (and potentially is associated with foregone COLAs. With reducing class size) whereas designating funds regards to a new COLA, we estimate providing a for foregone or new COLAs likely would result 1.66 percent COLA to all school and community in many districts increasing teacher salaries. college programs in 2013-14 would cost about Designating funds for uniform COLAs, $850 million. The cost of equalizing per-pupil however, would perpetuate existing inequities funding or implementing a weighted student in per-pupil funding whereas designating formula would depend on the way the initiatives funds for equalization would help remedy these are designed and implemented. inequities. (For instance, Proposition 98 general purpose per-pupil funding, consisting of revenue Funding Sufficient to Pay Down Existing limits and now flexible categorical funding, was Obligations and Build Up Base Ongoing roughly $1,400 higher in 2011-12 at San Jose Support. Over the coming five years, we project Unified than Fremont Unified—two equally that funding increases likely will be sufficient sized districts located relatively close to each to retire all the state’s outstanding one-time other.) These same basic trade-offs also apply if education obligations while simultaneously the Legislature were to decide to allocate all or a building up ongoing funding significantly. To portion of any funding increase using a weighted ensure outstanding one-time obligations are student formula rather than existing funding retired during this period of economic recovery, formulas. For example, the Legislature might we recommend the Legislature build a plan set base per-student funding under the new that steadily pays down these obligations, formula at the statewide average rate assuming with the obligations completely retired by the restoration of recent base reductions to revenue end of 2017-18 (at which time Proposition 30 limits and then use any funding increase to income tax increases will be triggering off). equalize per-pupil rates to this level. Paying down these obligations is important for constitutional, legal, and fiscal reasons. Paying Caution Against More Categorical outstanding mandate claims is a constitutional Programs. Based on current state law, categorical requirement, the Emergency Repair Program flexibility provisions are set to expire at the is a statutory commitment relating to a court- end of 2014-15. These provisions allow school approved settlement, and eliminating deferrals/ districts to use the funds associated with about making state payments on time is good fiscal 40 categorical programs for any educational practice. Because of the one-time nature of these purpose. (The flexibility provided to the K-3 obligations, the Legislature could retire them Class Size Reduction program is set to expire even as it builds up ongoing base support. a year earlier—at the end of the budget year.) Recent surveys we conducted indicate that Carefully Consider How Best to Build most school districts have redirected the bulk Up Base Support. As indicated earlier, the 33 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook of these now flexible categorical dollars toward requirement. (In the case of CSU, which already supporting core programs. Moreover, survey approved and implemented a tuition increase, responses indicate that the vast majority of the university has rescinded the increase and will districts believe categorical flexibility has refund students accordingly.) Though unlikely facilitated developing and balancing budgets to increase tuition in 2012-13, the universities as well as made dedicating resources to local indicate they are considering increasing tuition education priorities easier. These findings for 2013-14. This would not affect their receipt of suggest that resurrecting pre-existing categorical the $125 million augmentations. programs likely would be counterproductive and potentially unworkable for districts. As part State Expenditures on Universities Assumed of his weighted student formula initiative, the to Be Flat Throughout Rest of Forecast Period. Governor also has expressed interest in removing Our forecast assumes that the universities’ many programmatic requirements. Furthermore, General Fund operating expenditures will a plethora of reports released throughout continue to be the same each year through the last decade by several policy groups have 2017-18. This projection relies upon three main concluded that the state’s existing categorical assumptions. First, we assume the state does not funding system has fundamental problems. All provide COLAs for the universities, consistent this suggests that districts likely would benefit with state law regarding no automatic COLAs little, if at all, from the state imposing additional for most state programs. Second, although we programmatic requirements on them. recognize additional student demand likely exists at CSU as a result of recent reductions in course Csu and uC offerings, we assume no enrollment growth at either CSU or UC given that the state has not The state has two public four-year university consistently funded enrollment growth in recent systems. The CSU, with 23 campuses and about years. Moreover, our demographic projections 430,000 students, primarily provides instruction show that growth in the traditional college-age for undergraduate and master’s students. The population will slow and then become negative UC, with ten campuses and about 240,000 by the end of the forecast period. Though future students, is a comprehensive research university enrollment demand at the universities depends offering instruction through the doctoral on many different economic and social forces, we level. Both systems receive support for their assume that any increases in college participation core instructional programs primarily from a rates generally would be canceled out by these combination of state funds and student tuition projected demographic declines. Finally, our revenue. forecast does not assume any additional state expenditures for other cost increases at the Near-Term Outlook. For 2012-13, we universities—such as expected increased costs for estimate General Fund operating expenditures UC’s pension plan. This is because the state has of $1.9 billion at CSU and $2.2 billion at UC. no specific funding obligation for this purpose. For 2013-14, we estimate expenditures will increase at each system by $125 million. Already Projected Expenditures Sensitive to authorized in the state’s budget plan, these Underlying Assumptions. The Legislature augmentations were contingent on the passage has significant discretion over university of Proposition 30 and require the universities to expenditures, unlike many other areas of maintain tuition in 2012-13 at the same level as the state budget that are constrained by 2011-12. We assume the augmentations occur, constitutional or federal requirements. At the as the systems indicate they plan to abide by this 34 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook same time, the universities have greater control consider how best to meet certain overarching over their total operating budget than most higher education objectives and then provide other government agencies supported by the specific corresponding augmentations. For state. This is because the universities have the example, if the Legislature sought to increase ability to raise additional revenue by increasing college participation, it could fund additional student tuition. These factors mean that the students at CSU, as its per-student cost is universities’ expenditures are very sensitive to significantly lower than for UC students. future legislative actions and the systems’ future decisions on tuition levels. student Financial Aid The state’s Cal Grant program guarantees Forecast Can help guide state Funding financial aid awards to recent high school Priorities for universities graduates and community college transfer Forecast Suggests Addressing Some students who meet financial, academic, and other University Budget Requests More Urgent eligibility criteria. The program also provides a Than Others. As indicated above, our forecast relatively small number of competitive grants assumes the state does not provide General Fund to students who do not qualify for entitlement augmentations for UC retirement costs, though awards. Cal Grants cover full systemwide tuition these costs are expected to increase throughout at the public universities for up to four years and the forecast period. If the state were to choose to partly contribute to tuition costs at nonpublic address these costs, General Fund expenditures institutions. Apart from tuition grants, some would rise notably above our forecasted levels, students qualify for grants that cover a portion as UC estimates an additional $360 million of their living costs. The program currently annually is needed to cover the associated is supported by the state General Fund, the costs for state-supported employees (reflecting Student Loan Operating Fund (SLOF), and a nearly 20 percent increase in UC’s General federal Temporary Assistance for Needy Families Fund costs). By comparison, given the projected (TANF) funds. slow growth and then decline in the college-age population, the Legislature is less likely to face Cal Grant Costs Projected to Increase corresponding enrollment growth pressures. Steadily Throughout Period. The 2012-13 Similarly, inflationary pressures are likely to be Budget Act provides $1.5 billion for the Cal quite low (hovering about 2 percent throughout Grant program ($645 million state General the forecast period). Fund, $804 million TANF, and $85 million SLOF). We project Cal Grant costs will grow Various Reasons Why Legislature Might Not to $1.6 billion in 2013-14—an increase of about Want to Treat Systems Identically Throughout $70 million (4 percent) from the current year. Forecast Period. Though the state’s budget plan We project these costs will continue to grow provides for an identical increase of $125 million steadily thereafter—reaching $2 billion in in 2013-14 for each system, the Legislature 2017-18—an increase of $500 million (33 percent) may wish to consider treating them differently from the 2012-13 level. Our forecast assumes moving forward. A more refined approach would SLOF support will end in 2016-17, requiring recognize that the two systems have different backfilling from the General Fund. We also missions, student populations, costs, tuition assume continued use of $804 million in TANF levels, alternative revenue sources, and outcomes. funds, offsetting a portion of Cal Grant costs Given all these differences, the Legislature could throughout the forecast period. 35 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook Major Forecast Assumptions. Cal Grant • Participation. Cal Grant participation has costs are affected by award amounts, program grown between 4 percent and 8 percent in eligibility policies, and the number of students recent years, despite constraints on campus participating in the program. Below, we highlight enrollments, as more students have applied the specific forecast assumptions we made in and qualified for need-based aid. We expect each of these areas. this trend to slow to 1 percent or 2 percent annually given previous participation • Tuition Increases. Recent trends in gains, new restrictions on Cal Grant tuition, coupled with recent reductions eligibility, improving economic conditions, in General Fund support, suggest that and little demographically driven growth. CSU and UC will continue to increase tuition. Though neither the state nor the Rapidly Growing Area of State Spending universities have established policies that Over Forecast Period. General Fund set tuition levels for the coming years, we expenditures for Cal Grants are projected to be assume moderate annual tuition increases about 90 percent higher in 2017-18 compared at CSU and UC throughout the forecast to current-year expenditures, with average period. Under current state policy, Cal annual growth of 14 percent over the period. Grant costs would rise to cover those (Because we assume TANF funding remains tuition increases. Over the course of the flat throughout the period and SLOF funding is forecast period, these potential tuition phased out over the next three years, the General increases would raise Cal Grant costs by Fund incurs all of the additional cost increases.) about $400 million, accounting for nearly This projected growth in General Fund spending 80 percent of projected growth in state is significantly higher than the projected financial aid costs. growth rate of nearly all other major areas of state spending. As indicated above, however, • Policy Changes. Our forecast also takes the forecast is highly sensitive to assumptions into account recent policy changes to the made regarding CSU and UC tuition levels. Cal Grant program. One of these changes Were the Legislature to act to constrain tuition relates to the California Dream Act, increases, then Cal Grant costs would decline Chapter 604, Statutes of 2011 (AB 131, significantly. Alternatively, if annual tuition Cedillo), which allows certain previously increases were implemented in the coming years, ineligible students to receive state financial then the Legislature might want to explore ways aid beginning in 2013. We project this to constrain the anticipated growth in associated will add some $60 million in annual costs Cal Grant costs. For example, it could limit to the Cal Grant program by 2017-18. award amounts for CSU and UC students to Our forecast also takes into account either a fixed amount or a share of tuition that program changes enacted in 2012 that varies according to student need. restrict institutional eligibility and reduce award amounts for students at nonpublic Child Care institutions. We project these changes The state provides subsidized child care initially reduce annual Cal Grant costs for children in families participating in the more than $30 million. We then expect CalWORKs program. Generally, CalWORKs these savings to decline somewhat over the families progress through three consecutive forecast period as students and institutions “stages” over the course of several years, adapt to the new policies. with Stage 1 intended for families seeking 36 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook employment, Stage 2 for families that have ($15 million) will be offset by costs associated gained stable employment and are transitioning with some of these families transitioning to the off of cash assistance, and Stage 3 for families Stage 3 program. For the non-CalWORKs child who have been off of cash assistance for at least care programs, we assume costs decline by less two years. Families may remain in Stage 3 until than 1 percent in 2013-14. This reflects a small their children “age out” of the program (turn 13) decline in the population of children under age or their income exceeds the eligibility threshold four, together with a suspension of the statutory (70 percent of the state median income). The COLA which continues through 2014-15. state also subsidizes child care for children from certain low-income working families not Increasing Costs Thereafter Due to Caseload participating in CalWORKs through the General Increases and COLAs. We project annual Child Care, Alternative Payment, and Migrant growth rates averaging 5 percent for Stage 2 and Child Care programs. Stage 3 throughout the remainder of the period as the state phases out short-term CalWORKs Child Care Costs to Dip in 2013-14, work-exemption policies that curbed child Increase Steadily Over Rest of Period. The care caseload rates in recent years. For the 2012-13 Budget Act included $751 million in non-CalWORKs programs, we project essentially non-Proposition 98 General Fund for subsidized flat funding in 2014-15, followed by annual child care and related support services. (This growth rates of 2 percent to 3 percent thereafter. total excludes funding for the State Preschool This reflects slow growth in the population of and Stage 1 programs, which are contained children under age four and statutory COLAs of within our Proposition 98 and CalWORKs roughly 2 percent in 2015-16 through 2017-18. forecasts, respectively.) We project no major changes in child care costs in the current year. Potential Loss of Federal Funding Could Moving forward, we project these costs will Affect State’s Child Care Programs. In addition drop to $717 million in 2013-14, a decline of to state funding, subsidized child care and 5 percent, then increase steadily to $884 million support services are supported with federal by 2017-18, an increase of 18 percent compared funding. Our forecast assumes the state’s federal to 2012-13. (Based on the Legislature’s budgeting Child Care and Development Fund (CCDF) approach in recent years, our forecast assumes allotment remains level across the period. Should the state does not provide an additional midyear the current federal sequestration plan—or other appropriation for the Stage 3 program in federal cuts to this grant—take effect, the state 2012-13—despite a projected increase in demand would have to choose whether to backfill the as a large number of families “time out” of the reductions with additional state General Fund Stage 2 program midyear. Our forecast, however, or make additional cuts to child care programs. does fund Stage 3 caseload growth in subsequent Unlike several grants identified for sequestration years.) cuts that support stand-alone federally funded initiatives, CCDF dollars generally are used Drop in Projected Budget-Year Costs interchangeably with state General Fund to Primarily Due to Declining Stage 2 Caseload. support the state’s child care programs. As a We anticipate a 10 percent ($43 million) result, the state likely would face greater pressure decrease in Stage 2 costs in 2013-14 based on to address a drop in federal funding for these exceptionally large cohorts of families “timing programs. out” of the program. A portion of these savings 37 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook heALTh ANd tax, the revenues from which were used to meet maintenance-of-effort (MOE) requirements huMAN serVICes imposed by the federal government on the state. Based on current law requirements, we project Overview of Services Provided. California’s that General Fund spending for HHS programs major health programs provide health coverage will increase to about $28.1 billion in 2013-14 and additional services for various groups of and $29.7 billion in 2014-15. Over the final three eligible persons—primarily poor families and years of the forecast, we project that spending children as well as seniors and persons with will increase on average by about $1.3 billion disabilities. The federal Medicaid program, each year, eventually reaching $33.5 billion. known as Medi-Cal in California, is the largest state health program both in terms of funding Although the average annual increase in and number of persons served. In addition, the HHS spending is 4.5 percent during the forecast state supports various public health programs, period, there is substantial variation in spending community services and state-operated facilities growth rates by program. General Fund for the mentally ill and developmentally disabled, spending for the state’s largest HHS program, and health care insurance for children through Medi-Cal, averages 6.8 percent per year during the Healthy Families Program (HFP). (The the forecast period. Conversely, the Supplemental HFP population is transitioning to Medi-Cal Security Income/State Supplementary Program beginning in January 2013.) Beyond these health (SSI/SSP) is projected to have average annual programs, the state provides a variety of human growth of 2.1 percent, while General Fund services and benefits to its citizens. These include spending for the CalWORKs program is income maintenance for the aged, blind, or projected to decline at an average annual rate of disabled; cash assistance and welfare-to-work 2.3 percent. services for low-income families with children; protection of children from abuse and neglect; Anticipated Lower Caseload Growth in and the provision of home-care workers who Some Programs Reduces Cost Pressures. The assist the aged and disabled in remaining in their recent recession raised unemployment and own homes. Although state departments oversee reduced income, resulting in historically high the management of these programs, the actual numbers of Californians enrolling in certain delivery of many services is carried out by county state HHS programs. As a result, caseload welfare and child support offices, and other local growth for several HHS programs from 2007-08 entities. Health programs are largely federally (the beginning of the recession) to 2011-12 (post and state funded, while most human services recession) was well above historical trends. For programs have a mixture of federal, state, and example, the CalWORKs caseload increased county funding. by about 27 percent over this period. Our economic forecast calls for modest but sustained Overall Spending Trends. The 2012-13 employment growth over most of the next five budget provided $26.7 billion in General years. Accordingly, our caseload projections for Fund spending for health and human services several HHS programs reflect substantially lower (HHS) programs. We now estimate that these growth rates compared to the experience of the General Fund costs in 2012-13 will be slightly recent recessionary years. This in turn reduces higher—about $26.9 billion—primarily due costs pressures. Below, we discuss spending to the July 1, 2012 sunset of the managed care trends in the major HHS programs. 38 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook Federal Patient Protection and enrollment processes and coordinating with Affordable Care Act (ACA) other public entities that will offer subsidized The ACA, also referred to as federal health health insurance coverage to low- and moderate- care reform, is far-reaching legislation that income persons. There will also be enhanced makes significant changes to health care outreach activities aimed at enrolling uninsured coverage and delivery in California. The individuals in health insurance coverage, scope of the ACA is so broad that it will be including Medi-Cal. years before all of its provisions will be fully Several Key Assumptions and Remaining implemented and its overall ramifications fully Policy Decisions Result in Significant Fiscal understood. Our forecast includes significant Uncertainty. Our fiscal estimates related to budgetary adjustments to account for the future ACA implementation are subject to substantial implementation of several significant ACA uncertainty and depend heavily on several key provisions, most of which affect the Medi-Cal assumptions, meaning that actual costs could Program and are discussed later in this chapter. be several hundreds of millions of dollars higher Some of these adjustments result in cost or lower over this period. In addition, the state increases for the state while others result in cost is still awaiting additional federal guidance on reductions. Below, we briefly summarize some of ACA implementation and several major state- the major ACA provisions that have a significant level policy decisions have yet to be made that effect on our spending projections over the would be critical to informing a projection of the forecast period. net fiscal impact of the ACA. Some of the major Authorizes Medicaid Expansion up to policy decisions facing the Legislature include: 133 Percent of the Federal Poverty Level (FPL). • Determining whether to adopt the Medicaid Beginning January 1, 2014, California has the expansion and how to fund it. option to expand coverage to include most adults under age 65 with incomes at or below • Selecting the benefits that would be 133 percent of the FPL who are not currently provided to the expansion population. eligible for Medi-Cal—hereafter referred to as the expansion population. Our forecast assumes • Determining how the state and local California will adopt the Medicaid expansion, governments will fund medical care although the Legislature has not yet enacted legislation to do so. As illustrated in Figure 4, the federal matching rate for coverage of the Figure 4 expansion population will be 100 percent for Federal Matching Rate for Medicaid the first three years, but will decline between Expansion Population 2017 and 2020, with the state eventually bearing Calendar Year Federal Matcha 10 percent of the additional cost of health care services for the expansion population. 2014 100% 2015 100 Makes Changes to Outreach, Enrollment 2016 100 Processes, and Eligibility Standards. Beginning 2017 95 2018 94 January 1, 2014, the ACA generally simplifies 2019 93 the standards used to determine eligibility for 2020 and thereafter 90 the Medi-Cal Program. In addition, the ACA a Enhanced federal match is for health care services only—not includes provisions aimed at streamlining the administrative costs. 39 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook provided to the remaining medically related to the ACA, most notably expanded uninsured population. eligibility beginning January 2014. (Absent the effect of any ACA provision and the HFP • Determining how the existing Medi-Cal transition, the number of individuals enrolled in eligibility standards and enrollment Medi-Cal under current eligibility rules would processes will change in response to the grow less than 1 percent annually.) The impacts new ACA requirements. of the ACA and HFP shift on our Medi-Cal spending forecast are discussed below. • Evaluating whether to modify existing state health programs that provide services Implementation and Expiration of Recent to persons who would become eligible for Actions to Reduce Costs. Our forecast makes Medi-Cal, or other federally subsidized several important assumptions about the health coverage, in 2014. ongoing General Fund cost reductions associated with recently passed legislation. Some of these Medi-Cal key assumptions include: Overall Spending Trends. We estimate that 2012-13 General Fund spending for Medi-Cal • Provider Payment Reductions local assistance administered by the Department Implemented in 2013-14. In 2011, budget- of Health Care Services will be $14.6 billion— related legislation authorized a reduction roughly the same General Fund spending that in certain Medi-Cal provider payments was assumed in the 2012-13 Budget Act. We by up to 10 percent. Currently, federal project that General Fund support will grow to court injunctions are preventing the $15.7 billion in 2013-14, an 8 percent increase state from implementing many of these from current-year expenditures. After 2013-14, reductions. Our forecast assumes the state we project that General Fund spending will will prevail in court and the payment increase by about 6.5 percent each year, reaching reductions—creating annual budget a total of $20.3 billion by 2017-18. Some of the savings of about $350 million—will be most significant factors contributing to the implemented starting in July 2013. estimated change in year-over-year spending over the forecast period are: (1) increases in • Hospital Fee Expiration. The hospital caseload and the per-person cost of providing quality assurance fee provides fee revenue health care services, (2) the full implementation that offsets General Fund costs for providing of budget actions initiated in prior years and children’s health coverage. Under current the expiration of temporary budget actions, and law, the fee expires on December 31, 2013. (3) the fiscal effects associated with implementing Our current-law forecast assumes that the the ACA. fee is not reauthorized after this date, and adds the $387 million cost of backfilling Key Program Cost-Drivers. We assume that the fee revenue with General Fund monies. the cost per person for Medi-Cal health care However, we note that it is an important services will grow at an average annual rate of policy choice for the Legislature to decide 5.8 percent over the entire forecast period. We whether or not to extend this fee. The project that the overall Medi-Cal caseload will Legislature has extended the fee twice since grow by 8.1 percent annually over the forecast its initial enactment, which has served to period due to (1) the transition of children increase Medi-Cal payments to hospitals enrolled in HFP to Medi-Cal and (2) factors without additional General Fund spending. 40 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook • Coordinated Care Initiative. The would have a significant impact on the 2012-13 Budget Act assumed net cost program’s total caseload beginning in reductions of $608 million from the 2014, the federal government will pay the Coordinated Care Initiative, an eight- large majority of the costs of the expansion county demonstration project that will during our forecast period. Our forecast enroll individuals who are eligible for both projects costs in the low hundreds of Medi-Cal and Medicare into managed millions of dollars in 2016-17 and 2017-18. care. These net cost reductions during the first year of implementation (2012-13) • Increased Costs for Persons Currently are mostly due to a $711 million payment Eligible, but Not Enrolled. We project deferral to Medi-Cal providers. Once that several ACA provisions—such as fully implemented, the demonstration is the individual mandate to obtain health estimated to save hundreds of millions insurance coverage and streamlined of General Fund dollars annually. Our Medi-Cal eligibility processes—will forecast adds the costs for backfilling increase the demand for Medi-Cal by the payment deferral with General Fund persons who are currently eligible but monies in 2013-14, and assumes savings have not enrolled in the program. Unlike from the fully-implemented demonstration for the expansion population, the state starting in 2014-15. will be responsible for 50 percent of the costs for services provided to persons who • Shift HFP Enrollees Into Medi-Cal. The are eligible under current standards. We 2012-13 Budget Act authorized the transition estimate these costs at nearly $100 million of nearly 900,000 children from HFP— beginning in 2013-14—increasing to California’s Children’s Health Insurance the low hundreds of millions of dollars Program (CHIP)—into Medi-Cal. This annually over the next several years. transition will occur in several phases over the course of calendar year 2013. Our • Reduced Costs for Other State Medi-Cal spending projections reflect Health Programs. As a result of ACA the costs of providing services to these implementation, we project reduced children once they are transitioned into General Fund spending for some the Medi-Cal Program. (Please see the non-Medi-Cal state health programs, “Healthy Families Program” write-up such as the Breast and Cervical Cancer below for a more detailed discussion of this Treatment Program and the Family transition and its budgetary impact.) Planning, Access, and Care Treatment Program. These programs currently pay Implementation of Federal Health Care for services for populations that will Reform. Our spending projections assume become newly eligible for Medi-Cal or that implementation of the ACA will have other subsidized health insurance coverage several significant fiscal effects on the Medi-Cal in 2014. We project about $100 million in Program. reduced General Fund costs in 2013-14, with annual ongoing reductions of about • Medi-Cal Expansion. As mentioned $200 million. There is a significant amount above, our forecast assumes the state will of uncertainty surrounding these estimates adopt the Medicaid expansion authorized as the fiscal effects will largely depend on under the ACA. While this expansion future policy decisions about the potential 41 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook modification of these existing programs in budget assumes a particular level of savings response to the ACA coverage expansions. from the transition of all HFP enrollees to Medi-Cal, which will begin on January 1, • Increased Federal Matching Rate for 2013 and occur over a 12-month time CHIP. Beginning October 1, 2015, the ACA period. As the HFP enrollees will now authorizes a 23 percentage point increase be transitioning at a slower rate than in the federal CHIP matching rate—from originally projected and assumed in the 65 percent to 88 percent. Our forecast budget, we project that HFP will require an assumes these additional federal funds will additional $13.6 million in General Fund offset about $150 million in annual General support in 2012-13 over budgeted levels. Fund spending in the Medi-Cal Program in By 2014-15, all HFP enrollees are projected 2015-16 and roughly $200 million annually to be enrolled in Medi-Cal. Our forecast in the following years. assumes that when fully implemented in 2014-15, the HFP transition to Medi-Cal healthy Families Program will result in ongoing net savings to the As we discussed earlier in this report, the state of about $70 million annually. 2012-13 Budget Act authorizes the transition of HFP enrollees into Medi-Cal beginning in department of state hospitals (dsh) January of 2013. The 2012-13 budget provides In 2012-13, state-level administration of $163 million from the General Fund for HFP, community mental health programs were which is administered currently by the Managed shifted from the Department of Mental Health Risk Medical Insurance Board. We estimate, (which was eliminated) to other departments, however, that an additional $197 million in and a DSH was created to administer the General Fund support will be required for HFP state’s hospitals and in-prison programs. We in 2012-13 due to the following two reasons: estimate the General Fund spending for DSH in 2012-13 will be about $1.3 billion and will grow • Unallocated Reduction in 2012-13 Will to more than $1.4 billion by 2017-18. General Need to Be Backfilled With General Fund. Fund spending would have remained virtually The 2012-13 budget includes a $183 million unchanged during the forecast period were it unallocated General Fund reduction not for an almost $90 million increase in annual to HFP. A proposed extension of a tax DSH staff costs to provide treatment services for imposed on managed care organizations mentally ill inmates at a new prison in Stockton used to offset General Fund costs would scheduled to open in July of 2013. have provided an equivalent amount of money for the support of HFP in 2012-13, developmental services but it was not enacted into law. Our forecast We estimate that the General Fund spending assumes that this reduction will need to be for developmental services in 2012-13 will total backfilled with General Fund support to almost $2.7 billion. We project that General avoid violating an MOE requirement under Fund support will grow to almost $2.8 billion ACA, as a violation of the MOE would in 2013-14 and to $3.2 billion in 2017-18. This jeopardize the state’s federal Medicaid projected expenditure growth is largely due to funding. increased caseload, utilization of services, and rising costs for community services provided • Children Enrolled in HFP Will Transition by regional centers. Our forecast assumes the to Medi-Cal at Slower Rate, Eroding regional center caseloads will grow at an annual Budgeted Savings in 2012-13. The 2012-13 42 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook average rate of 4 percent, and that costs overall increase by about $150 million in 2013-14, will grow at an average annual rate of about remain essentially flat in 2014-15, and then 6 percent. decline in each of the next three years to around $1.4 billion in 2017-18. The increase in In-home supportive services (Ihss) CalWORKs General Fund costs in the near term We project that General Fund spending is primarily the result of (1) the restoration of for IHSS will increase from $1.7 billion in the funding due to the expiration of some short-term current year to more than $1.8 billion in 2013-14 work exemptions, (2) increased grant costs and then grow steadily in subsequent years by resulting from a higher earned-income disregard, around $70 million per year. These expenditure and (3) the state’s fixed federal TANF block increases are primarily driven by caseload grant, which does not adjust for caseload and growth. Specifically, our forecast assumes that policy changes. Other significant policy changes, IHSS caseload will grow at 3 percent per year including the introduction of a 24-month limit throughout the forecast period. This assumption on CalWORKs participation under state work takes into account recent trends, including participation rules, are forecast to have lesser, growth in the aging population and economic but much more uncertain, impacts on spending. fluctuations, as well as recent program policy Long-term spending declines are primarily changes that have reduced the caseload growth driven by projected declines in caseload levels. rate. Cost of Restoring Funding Due to Expiration Budget Solutions and Unrealized Savings. of Work Exemptions. The Legislature achieved Our forecast for IHSS assumes that the state does CalWORKs savings in the 2012-13 budget by not prevail in current litigation challenging its (1) extending for an additional six months legal ability to implement a 20 percent reduction and then gradually phasing out a temporary in IHSS service hours (this reduction was a exemption from work participation enacted in component of the 2011-12 budget’s revenue 2011-12 for households with young children, trigger that was pulled). However, if the state corresponding to a $364 million reduction were to prevail, it would result in General Fund in county block grants for employment savings of around $29 million in 2012-13 and services and child care, and (2) creating a new close to $115 million in full-year, ongoing savings permanent, but more limited, exemption from beginning in 2013-14. work participation to take effect as the previous exemption is discontinued. Our forecast reflects CalWOrks the gradual restoration of county block grant Overall Spending Trends. For 2012-13, the funds beginning in 2012-13 and continuing into state budget provided $1.6 billion from the 2014-15. This is offset somewhat by new ongoing General Fund for CalWORKs. This amount savings resulting from the new permanent reflects both $470 million in CalWORKs exemption. Our forecast assumes an annual net budgetary savings and a funding swap between cost of approximately $210 million relative to CalWORKs and the California Student Aid current levels once old exemptions are completely Commission. This funding swap decreased phased out. We note that the state General federal funding for CalWORKs by $804 million Fund bears 100 percent of these costs because and increased General Fund in CalWORKs by a the federal TANF block grant and county like amount, with no net impact on CalWORKs realignment funds do not adjust for caseload or or General Fund expenditures. From this policy changes. current-year base, we project spending will 43 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook Cost of Restoring Earned-Income Disregard likely means that some CalWORKs participants to Previous Levels. In the 2011-12 budget, the will exhaust the 24-month period and not earned-income disregard, which lessens the meet federal work participation requirements, grant reduction that a CalWORKs household resulting in the loss of the adult portion of the experiences when its earned income grows, was household’s grant through sanction. This would lowered. This effectively lowered the income also result in savings; however, grant savings level at which CalWORKs households become from sanctioned cases will be less significant ineligible for benefits because of increased than grant savings from households becoming earnings. The lower earned-income disregard also ineligible for CalWORKs through employment. decreased grants for remaining households with Our forecast assumes that the introduction of earnings. The 2012-13 budget restored the earned- the 24-month clock will result in decreased costs income disregard to its previous level, effective to the General Fund, though the timing and October 2013. This change is projected to increase magnitude of these savings are uncertain. grant costs by (1) increasing the maximum income a CalWORKs household can earn and remain Caseload Levels Driven Primarily by eligible, leading to a slightly larger caseload; and Economic Conditions. Historically, changes in (2) increasing the grants of current CalWORKs employment levels have significantly affected households that have earnings. A higher earned- CalWORKs caseload growth. During the recent income disregard may also have the effect of economic downturn, the growth rate of the encouraging work, which could eventually CalWORKs caseload increased substantially, decrease grant costs. This effect, however, is peaking during the 2011-12 fiscal year. uncertain and difficult to accurately predict. Our Consistent with previous periods of employment forecast assumes an ongoing cost of approximately growth, the CalWORKs caseload is projected to $120 million, which would diminish over time decline over the next five years as the state of the with expected caseload declines. economy improves. Impact of New 24-Month Time Limit Is ssI/ssP Uncertain. The 2012-13 budget also introduced State expenditures for SSI/SSP are estimated a new 24-month limit on program eligibility to be about $2.8 billion in 2012-13, and increase under state work participation rules, which by about $60 million annually through 2017-18, now provide a wider range of options for when expenditures are projected to reach close to meeting work participation requirements than $3.1 billion. The projected spending increases are is available under federal work participation primarily due to average annual caseload growth rules. After 24 months, work-eligible adult of about 1.8 percent. participants are required to comply with federal rules or be sanctioned (which results in the loss of the adult portion of the household’s grant). JudICIArY ANd The eventual effects of this new policy on the CrIMINAL JusTICe CalWORKs caseload and program costs are uncertain. Increased flexibility under state work participation rules may lead to more CalWORKs The major state judiciary and criminal justice participants finding employment that reduces programs include support for two departments or eliminates their grants. This would result in in the executive branch—CDCR and the caseload reductions and grant savings. At the Department of Justice—as well as expenditures same time, the limited duration of this flexibility for the state court system. 44 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook CdCr offenses; (2) individuals released from state We estimate that total spending for support prison whose most recent offense is not classified of CDCR operations in the current year will as serious or violent; and (3) state parolees who be about $8.6 billion, which is $394 million, or are incarcerated following a violation of the about 4 percent, less than the 2011-12 level of terms and conditions of their supervision. To spending. This decrease primarily reflects the fund realignment, the state shifted a share of the reduction of the inmate and parolee populations state sales tax, as well as some other revenues to occurring as a result of 2011 policy changes local governments. to “realign” certain state offenders to local jurisdictions, as discussed in more detail below. As a result of these realignment sentencing In 2011-12, $1.2 billion of funding designated changes, the state inmate and parolee for this realignment was, on a one-time basis, populations are projected to decline significantly. provided to the state to offset its General Fund As shown in Figure 5, we project the total inmate costs to house and supervise those offenders population to decline from 162,400 inmates still in prison or on parole who otherwise would prior to realignment to 129,400 at the end of have been eligible for realignment if they had the forecast period. We project the parolee Graphic Sign Off been sentenced after its implementation date. population to decline from 105,400 parolees prior Consequently, General Fund spending for to realignment to about 32,200 at the end of tShee cretary support of CDCR operations in the current forecast period. These projections include the Analyst year will be higher than in 2011-12, increasing estimated impact of Proposition 36, approved by Director by $737 million, or 9 percent. Our forecast voters in November 2012. The measure modifies projects that General Fund spending on the state’s Three Strikes law and is projected tDo eputy corrections will decrease to about $8.3 billion reduce the prison population somewhat. by 2017-18 primarily due to additional reductions in the inmate and parolee populations Figure 5 due to realignment. (These Inmate and Parolee Populations totals exclude compensation Projected to Decline Significantly changes for some CDCR employees, which are 180,000 accounted for elsewhere in Inmates the forecast.) 160,000 Parolees Realignment. Beginning 140,000 October 1, 2011, state law 120,000 shifted—or “realigned”— responsibility for the 100,000 supervision and incarceration 80,000 of certain felon offenders 60,000 from the state to counties. Generally, offenders affected 40,000 by the policy are (1) newly 20,000 convicted inmates with no current or prior convictions for serious, violent, or sex 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 45 Legislative Analyst’s Office www.lao.ca.gov ARTWORK # California’s Fiscal Outlook The CDCR “Blueprint.” In April 2012, the of the components of the blueprint requiring administration released a plan (commonly legislative action, including financing authority referred to as the blueprint) to redesign much for the capital outlay projects. of CDCR’s prison and parole operations in light of its significant caseload reductions under LAO Forecast Assumes Implementation realignment. This plan included, among other of the Blueprint but at 137.5 Percent Prison changes, more standardized staffing levels across Cap. Our forecast generally assumes successful prisons, changes in how inmates are classified implementation of the CDCR blueprint. This and assigned to different security levels of means that there could be additional General housing, elimination of the use of out-of-state Fund costs to CDCR if the inmate and parolee contracted beds, and the closure of one prison. populations end up being higher than current The plan also included the construction of three projections or if CDCR is unsuccessful at new “infill” housing units at existing prisons, implementing components of the blueprint as well as the renovation and conversion of a expected to result in state savings. Our forecast, closed juvenile justice facility to a prison for adult however, differs from the blueprint by assuming inmates. Finally, the blueprint assumed that that the federal three-judge panel does not the administration would be able to persuade approve the administration’s plan to seek an a federal three-judge panel to increase the increase in the court-ordered prison population prison population cap the panel ordered from cap to 145 percent of design capacity. (We 137.5 percent of design capacity to 145 percent. discuss the most recent court developments on (Design capacity generally refers to the number this issue in the nearby box.) Consequently, our of beds CDCR would operate if it housed only forecast assumes that about 10,900 inmates will one inmate per cell and did not use temporary be housed in out-of-state contracted beds in beds, such as housing inmates in gyms. Inmates order meet the court-ordered prison population housed in contract facilities are not counted limit. In total, we forecast CDCR General Fund toward the overcrowding limit.) As part of the expenditures to decline by about $300 million 2012-13 budget, the Legislature approved most from the 2012-13 level due to projected caseload Federal Court Order to reduce Prison Overcrowding On May 23, 2011, the U.S. Supreme Court upheld the ruling of a federal three-judge panel requiring the state to reduce overcrowding in its prisons to 137.5 percent of the system’s overall “design capacity” by June 27, 2013. Currently, the state prison system is operating at roughly 150 percent of design capacity—or about 10,000 inmates more than the limit established by the three-judge panel. In August 2012, the plaintiffs in the prison overcrowding case filed a motion arguing that the administration’s plan to reduce the prison population to only 145 percent of design capacity was in violation of the court’s orders, and the administration should be ordered to produce a plan to comply with the order to meet a lower population limit. On September 7, 2012, the three-judge panel issued an order indicating that the court will not entertain any motion from the administration to increase the population cap (though the court raised the possibility of extending the deadline by six months). In a subsequent order, the court required that by January 7, 2013 the administration and the plaintiffs submit plans to the court—including specific population reduction measures that could be implemented—to reduce the population to 137.5 percent of design capacity by June 27, 2013 and December 27, 2013. 46 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook changes and implementation of the blueprint. $1.1 billion we project for 2013-14. As discussed These savings are somewhat offset by an below, all estimates related to RDAs are subject to additional $155 million annually to operate a new considerable uncertainty and are likely to change prison complex in Stockton designed to improve significantly between now and the deadline for the provision of inmate health care. adopting the 2013-14 budget in June 2013. Judicial Branch Background. As the operations of former We estimate that General Fund spending RDAs wind down, their resources are being for the support of the judicial branch in the redistributed to other local agencies (cities, current year will be about $730 million, roughly counties, special districts, schools, and $500 million lower than the amount in 2011-12. community colleges). These resources include This reduction reflects budget actions to reduce (1) property tax revenue not needed to pay General Fund support for the branch and RDA debts (residual property tax revenue) and offset most of the reduction to the trial courts (2) unencumbered RDA cash and other liquid with the one-time use of funds from a court assets. (Distribution of the proceeds from the construction account and trial court reserves. sale of some former RDA real estate holdings Beginning in the budget year, we estimate may occur at a future date.) County auditor that General Fund support for the judicial controllers distribute these RDA resources to branch will be about $1.2 billion, similar to the local agencies in a manner similar to how they 2011-12 level. This reflects (1) the restoration distribute property tax revenues. Most of the of $419 million of the current-year reductions RDA resources provided to K-14 districts offset (leaving a net $71 million in ongoing unallocated required state General Fund education spending, cuts to the trial courts); (2) additional costs of thereby creating savings for the state. $35 million beginning in 2013-14, growing to over $50 million annually, for service payments Residual Property Tax Revenue. Our forecast for the Long Beach Courthouse currently under estimates that 2012-13 state savings from the construction; and (3) over $10 million annually distribution of residual property tax revenues beginning in 2013-14 to hold parolee revocation to schools will be around $700 million. This is hearings, a responsibility that will be shifted to about $1 billion less than assumed in the 2012-13 the courts from the Board of Parole Hearings budget. Our lower estimate is based on several pursuant to the 2011 realignment legislation. factors: • Distributions made to K-14 districts this summer were significantly lower than OTher PrOgrAMs expected. redevelopment dissolution • Recent information suggests that RDA The state’s 2012-13 budget package assumed debts are higher than was anticipated. that the General Fund would save about $3.2 billion in school funding expenses due • K-14 districts’ proportionate share of to the dissolution of local redevelopment residual property taxes is lower than was agencies (RDAs), as described below. Currently, expected. we estimate that this savings will total about $1.4 billion—$1.8 billion less than assumed in • Some residual property taxes are distributed the budget. Additional savings will benefit the to K-14 districts that do not receive state General Fund annually in the future, such as the funding for apportionments (so-called 47 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook “basic aid districts”). These residual General Fund savings through the collective property taxes do not offset state education bargaining process, furloughs, and existing costs. administrative authority. To achieve these savings, the administration (1) negotiated We estimate state savings from residual a Personal Leave Program (PLP) with most property tax distributions in 2013-14 will be bargaining units, (2) extended the PLP to about $500 million. These savings should grow excluded employees, and (3) imposed furloughs over the forecast period, climbing to about on two bargaining units that did not agree to $900 million by 2017-18. For the next several the PLP. Furloughs and the PLP are functionally years, we anticipate that the funding needed to the same policy—for the 12 months of 2012-13, pay RDA debts will remain relatively flat. For this employees’ pay is reduced by about 5 percent in reason, growth in residual property taxes will exchange for one day off each month. be driven primarily by growth in former RDA property tax revenues. Increased Costs Beginning in 2013-14. Our forecast assumes that state General Fund Liquid Assets. Our forecast assumes that the employee compensation costs will increase by state will realize total one-time savings of about more than $750 million beginning in 2013-14. $1.3 billion from the distribution of former RDA This amount reflects: liquid assets to K-14 districts, including about $700 million in 2012-13 and about $600 million • The scheduled end to the PLP and furloughs in 2013-14. Our projected savings for 2012-13 are in June 2013 ($401.7 million). about $800 million lower than assumed in the budget package. • An increase of between 3 percent and 5 percent in the top step of the salary range Uncertainties Abound. We caution that our for 15 bargaining units and most excluded estimates are subject to significant uncertainty employees in July 2013 as specified in and could vary by several hundred million current law ($210 million). The state’s six dollars annually, with a somewhat greater other bargaining units received similar pay chance of savings being below our estimates increases pursuant to their memoranda of than above them. Several factors contribute to understanding (MOUs) in 2012. the difficulty of developing an accurate estimate. First, although the data used to develop our • Increases in the premium costs for state estimates are the best currently available and employees’ health care benefits averaging include some reports not available at the time about 9 percent ($136 million). The the 2012-13 budget was adopted, the data are California Public Employees’ Retirement very limited. Second, the willingness of RDA System (CalPERS) negotiates health successor agencies—the entities overseeing the premium rates each year. We expect health dissolution of the agencies—to comply with state premiums to continue increasing at a rate direction regarding redevelopment dissolution exceeding inflation for the foreseeable future. has been uneven. Finally, the outcomes of current Our forecast does not include any change and expected future litigation regarding RDA in state costs associated with new MOUs dissolution could affect state savings. that could be approved by the Legislature in the future for the 20 bargaining units employee Compensation with MOUs that expire during the forecast The 2012-13 budget package directs the period. administration to achieve over $400 million in 48 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook Future Costs of Unused Leave Uncertain. forecast relies on preliminary actuarial estimates Over the years, many state employees have of AB 340’s effects by CalPERS. carried large balances of unused vacation and other types of leave. These leave balances grew In part because of AB 340, our forecast significantly recently in part because of the state’s assumes that General Fund state pension furlough and PLP policies. When an employee contributions for state and CSU employees retires or leaves state service, the state must remain relatively flat through 2017-18 at around compensate the employee for this leave balance $2.2 billion per year. Implicit in this rough (“cashing out”) or allow him or her to draw estimate is an assumption that state employee pay without working (“burning off” the leave salaries will remain fairly flat throughout balance). Either of these two methods can result the period (except for salary increases in in additional state costs. The state budget process already-approved labor agreements) and that does not systematically augment departments’ CalPERS will hit its annual target for 7.5 percent budgets to cover such additional costs when they investment return. Moreover, our forecast arise. Accordingly, our forecast does not assume assumes no changes in CalPERS’ current any increased state costs associated with these actuarial assumptions, including its investment leave balances. Nevertheless, in some cases, the return assumptions, its existing methods for Legislature has augmented departmental budgets “smoothing” investment losses over many years, for extraordinary leave balance or similar and its current method of “pooling” together costs in order to prevent an erosion of funding assets and liabilities related to the pensions available for state services. Such augmentations of past, current, and future state employees. hypothetically could total tens of millions or Changes in these assumptions would tend to hundreds of millions of dollars in any year increase state costs noticeably if they occur during our forecast period, thereby increasing during our forecast period. General Fund expenditures above the level that Retiree Health Costs Continue to Climb we are forecasting. Rapidly. The state pays its unfunded health and retirement Benefit Costs dental benefit liabilities for retired state and Pension Legislation to Result in Some State CSU employees as they become due—when the Savings. Our forecast considers the savings in retirees’ benefit premiums have to be paid. This state employer pension contributions that are means that retiree health and dental benefits expected to result from this year’s major pension earned years—or even decades—ago by past legislation, Chapter 296, Statutes of 2012 (AB 340, employees are paid years later by taxpayers Furutani). In the near term, these savings will who may not have benefited directly from the result primarily from the legislation’s mandated employees’ past service. The resulting costs are increase in employee pension contributions much higher than if the normal costs for these by various groups of state employees. These benefits had been contributed and invested increases were intended to bring these state earlier. As more and more retirees have left state employees’ pension contributions up to the service and are living longer than prior retirees, new statewide “standard” of a 50/50 employer/ these costs have been a rapidly growing part of employee split of pension “normal costs” (the the state budget for some time. They will remain amounts that need to be set aside each year and so. Our forecast assumes that the combination invested in order to cover all future costs of of health premium increases and the growth of benefits earned in that year by employees). Our the retiree population will cause expenditures from the General Fund retiree health 49 Legislative Analyst’s Office www.lao.ca.gov California’s Fiscal Outlook expenditure item to grow from $1.6 billion debt service on Infrastructure Bonds in 2012-13 to $2.7 billion in 2017-18—an The state uses General Fund revenues to average annual growth rate of 11.9 percent. pay debt-service costs for principal and interest (Around 40 percent of these General Fund payments on two types of bonds used primarily costs eventually are offset by pro rata and to fund infrastructure—voter-approved general cost recovery payments from special and obligation bonds and lease-revenue bonds other funds. These figures do not consider the approved by the Legislature. We estimate that “implicit subsidy” the state provides to retiree General Fund costs for debt service on these health premiums through its contributions to bonds will be $5.1 billion in 2012-13, which active employees’ benefits.) is roughly equal to the state’s General Fund debt-service costs every year since 2009-10. CalSTRS Liabilities Are a Serious Long-Term General Fund debt-service costs have not Fiscal Issue. State, school district, and teacher increased significantly over this period for a contributions to the California State Teachers’ few reasons. Most notably, the Legislature and Retirement System (CalSTRS) for pension Governor enacted legislation to permanently benefits are set in state law. In general, CalSTRS’ offset some General Fund debt-service costs governing board has no power to adjust these with transportation funds. The 2012-13 budget contributions, despite the fact that the statutory package also achieved savings over three fiscal stream of payments from these sources will not years by offsetting housing debt-service costs with be sufficient to fund benefits over the long term. proceeds from the National Mortgage Settlement. Our forecast assumes that the state’s current-law Additionally, the administration slowed the pace payments to CalSTRS remain relatively flat in of bond sales over the last two years. the near term at about $1.4 billion per year due to the effects of recently constrained school Over the forecast period, however, General district budgets on teacher payroll. By 2015-16, Fund debt service is projected to grow 7.8 percent our forecast assumes that current-law payments annually, reaching $7.4 billion by 2017-18. to CalSTRS will begin to grow steadily, reaching Projections of debt-service costs depend $1.6 billion by 2017-18. Over the entire forecast primarily on the volume of future bond sales, period, we forecast an average annual growth their interest rates, and their maturity structures. rate of 3.5 percent per year. The exact timing of bond sales depends upon when various programs will need bond funds Because our forecast assumes only and the accessibility of financial and credit current-law state payments to CalSTRS, it markets. In general, our forecast assumes that assumes no additional costs or policy changes the slower pace of bond sales continues for to preserve CalSTRS’ solvency. Substantial many programs because they currently have additional contributions from some source will sufficient bond proceeds to cover their spending be required to address CalSTRS’ unfunded needs during the initial portion of the forecast. liabilities and the resulting issues for the system’s Nonetheless, over the entire forecast period, long-term solvency. Alternatively (or in addition we assume that a total of about $34 billion to these higher contributions), benefits for future of already authorized general obligation and teachers could be reduced further (in addition lease-revenue bonds will be sold as currently to the changes in AB 340) and the resulting approved projects move forward. A large share savings could be redirected to cover the system’s of this—about $25 billion—is from the nearly unfunded costs. $54 billion in infrastructure bonds authorized by voters in 2006 and 2008. We also expect that 50 www.lao.ca.gov Legislative Analyst’s Office California’s Fiscal Outlook transportation debt-service costs will exceed insolvent since 2009, requiring the state to available transportation funds during the borrow from the federal government to continue forecast period and the General Fund will pay payment of UI benefits. California’s outstanding the remaining costs. Our forecast is based on the federal loan is estimated to be $10.2 billion at expected sale of bonds that have already been the end of 2012. The state is required to make authorized, but does not include any additional annual interest payments on this federal loan. bonds that may be authorized by the voters or These interest costs total $308 million in 2012-13. Legislature during the forecast period. The budget authorizes this interest payment from the General Fund. To offset this cost, Debt-Service Ratio (DSR) Expected to the budget provides a loan of a like amount Remain Around 6 Percent. The DSR for general from the Disability Insurance Fund to the obligation and lease-revenue bonds—that is, General Fund. Based upon the Employment the ratio of annual General Fund debt-service Development Department’s projections of the costs to annual General Fund revenues and future unemployment rate, benefit payments, transfers—is often used as one indicator of and UI Trust Fund revenues, we project that the state’s debt burden. There is no one “right” the General Fund annual interest payments on Graphic Sign Off level for the DSR. The higher it is and more the outstanding loan principal will gradually rapidly it rises, however, the more closely bond decline each year from $308 million in 2012-S13e tcor etary raters, financial analysts, and investors tend to approximately $200 million in 2017-18. Analyst look at the state’s debt practices and the more Director debt-service expenses limit the use of revenues Our projections for the interest payments for other programs. Figure 6 shows what from the General Fund do not incorporate Deputy California’s DSR has been in the recent past and any potential actions, such as an increase in our DSR projections for the forecast period. We UI taxes or decrease in benefits, that could be estimate that the DSR will remain around 6 percent throughout the forecast Figure 6 period. This is because Projected Debt-Service Ratioa General Fund debt service and General Fund (including 7% EPA) revenues are expected Authorized, but Unsold to grow at similar rates. 6 To the extent additional 5 bonds are authorized and sold in future years beyond 4 those already approved, the state’s debt-service costs and 3 DSR would be higher than Bonds Already Sold projected in Figure 6. 2 1 unemployment Insurance (uI) Interest Payments on 85-86 90-91 95-96 00-01 05-06 10-11 15-16 Federal Loan. California’s Forecast UI Trust Fund has been a Ratio of annual General Fund debt-service payments to General Fund and Education Protection Account revenues and transfers. 51 Legislative Analyst’s Office www.lao.ca.gov ARTWORK #120534 California’s Fiscal Outlook taken during the forecast period to address the federal unemployment tax credit for which the underlying UI Trust Fund insolvency and employers are eligible (up to 5.4 percentage reduce the state’s interest payment obligation to points of the total 6 percent tax on employee the federal government. For forecast purposes, wages up to $7,000) is incrementally reduced we also do not assume that the General Fund for each year that the state continues to have an interest obligation would be met in future years outstanding federal loan to the UI Trust Fund. by creating new alternative funding sources or The increase in federal unemployment taxes through additional special fund loans to the paid by California employers due to the tax General Fund (although there is the potential for credit reduction—approximately $290 million in such actions). We note, however, that pursuant 2012—is used to reduce the federal loan balance. to federal law and beginning in tax year 2011, 52 www.lao.ca.gov Legislative Analyst’s Office LAO Publications The Legislative Analyst’s Office (LAO) is a nonpartisan office which provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an E-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814.